Corporate and Other operating income loss primarily comprises revenue deferrals and corporate-level activity not specifically allocated to a segment, including impairment, integration, and restructuring expenses. 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.

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.

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. Impairment, integration, and restructuring expenses include costs associated with the impairment of goodwill and intangible assets related to our phone business, employee severance expenses and costs associated with the consolidation of facilities and manufacturing operations related to restructuring activities, and systems consolidation and other business integration expenses associated with our acquisition of NDS.

Our annual goodwill impairment test as of May 1, indicated that the carrying value of our previous Phone Hardware reporting unit goodwill exceeded its estimated fair value. All remaining goodwill and intangible assets are included in our Devices reporting unit, within More Personal Computing under our current segment structure.

We use derivative instruments to: manage risks related to foreign currencies, equity prices, interest rates, and credit; enhance investment returns; and facilitate portfolio diversification. Gains and losses from changes in fair values of derivatives that are not designated as hedges are primarily recognized in other income expense , net.

Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains losses are generally economically offset by unrealized gains losses in the underlying available-for-sale securities and gains losses on certain balance sheet amounts from foreign exchange rate changes. Dividends and interest income increased due to higher portfolio balances and slightly higher yields on fixed-income securities.

Interest expense increased due to higher outstanding long-term debt. Net recognized gains on investments decreased primarily due to higher other-than-temporary impairments and lower gains on sales of fixed-income securities, offset in part by higher gains on sales of equity securities. Net losses on derivatives increased due to higher losses on currency and equity contracts and lower gains on interest rate contracts in the current period as compared to the prior period, offset in part by lower losses on commodity contracts.

For fiscal year , other reflects recognized losses from divestitures and certain joint ventures. Dividends and interest income decreased due to lower yields on fixed-income securities, offset in part by higher portfolio balances. Net recognized gains on investments increased primarily due to higher gains on sales of equity securities, offset in part by higher other-than-temporary impairments.

Net losses on derivatives increased due to losses on commodity contracts in fiscal year as compared to gains in fiscal year , offset in part by lower losses on currency and equity contracts. For fiscal year , other reflects recognized losses from certain joint ventures and divestitures.

Our effective tax rate was lower than the U. The decrease in our effective tax rate for fiscal year compared to fiscal year was primarily due to changes in the mix of our income before income taxes between the U.

The fiscal year effective tax rate included the tax impact of losses in foreign jurisdictions for which we may not realize a tax benefit, primarily as a result of impairment and restructuring charges. The mix of income before income taxes between the U. We supply our Windows PC operating system to customers through our U. In fiscal year , our U. Net revenue deferrals related to sales of Windows 10 negatively impacted our fiscal year U.

Impairment, integration, and restructuring expense relating to our phone business decreased our fiscal year U. On July 27, , the U. Tax Court issued an opinion in Altera Corp. Commissioner related to the treatment of stock-based compensation expense in an intercompany cost-sharing arrangement.

This decrease relates primarily to tax credits available for carryover and a partial settlement of the IRS audit for tax years to , offset by increases relating to intercompany transfer pricing. While we settled a portion of the IRS audit for tax years to during the third quarter of fiscal year , and settled a portion of the IRS audit for tax years to during the first quarter of fiscal year , we remain under audit for those years.

In February , the IRS withdrew its Revenue Agents Report for tax years to and reopened the audit phase of the examination. As of June 30, , the primary unresolved issue relates to transfer pricing, which could have a significant impact on our consolidated financial statements if not resolved favorably. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months.

Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months. We also continue to be subject to examination by the IRS for tax years to We are subject to income tax in many jurisdictions outside the U.

Our operations in certain jurisdictions remain subject to examination for tax years to , some of which are currently under audit by local tax authorities. The resolutions of these audits are not expected to be material to our consolidated financial statements. In fiscal year , this reduction was mostly offset by losses in foreign jurisdictions for which we may not realize a tax benefit, primarily as a result of impairment and restructuring charges.

Changes in the mix of income before income taxes between the U. In fiscal years and , our U. Our short-term investments are primarily intended to facilitate liquidity and for capital preservation. They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers. The investments are predominantly U. 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. The remaining cash equivalents and short-term investments held by our foreign subsidiaries were invested in foreign securities. We lend certain fixed-income and equity securities to increase investment returns.

The loaned securities continue to be carried as investments on our consolidated balance sheets. Collateral received is recorded as an asset with a corresponding liability. Intra-year variances in the amount of securities loaned are mainly due to fluctuations in the demand for the securities. In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments.

This pricing methodology applies to our Level 1 investments, such as exchange-traded mutual funds, domestic and international equities, and U. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly.

This pricing methodology applies to our Level 2 investments such as corporate notes and bonds, common and preferred stock, foreign government bonds, mortgage- and asset-backed securities, U.

Level 3 investments are valued using internally developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial portion of our portfolio.

A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as these vendors either provide a quoted market price in an active market or use observable inputs for their pricing without applying significant adjustments.

Broker pricing is used mainly when a quoted price is not available, the investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments because the broker prices these investments based on similar assets without applying significant adjustments.

In addition, all of our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments. Our fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate.

We issued debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt.

Unearned revenue as of June 30, was comprised mainly of unearned revenue from volume licensing programs. Unearned revenue from volume licensing programs represents customer billings for multi-year licensing arrangements paid for either at inception of the agreement or annually at the beginning of each coverage period and accounted for as subscriptions with revenue recognized ratably over the coverage period.

Unearned revenue as of June 30, also included payments for: Windows 10 licenses; post-delivery support and consulting services to be performed in the future; Office subscriptions; Xbox Live subscriptions; Microsoft Dynamics business solutions products; Skype prepaid credits and subscriptions; Bundled Offerings; and other offerings for which we have been paid in advance and earn the revenue when we provide the service or software, or otherwise meet the revenue recognition criteria.

The following table outlines the expected future recognition of unearned revenue as of June 30, While the program has no expiration date, we intend to complete it by December 31, 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 indemnifications, we consider factors such as the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations did not have a material impact on our consolidated financial statements during the periods presented. The following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, We expect the acquisition will close in calendar year , and we will finance the transaction primarily through the issuance of new debt.

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 in support of our productivity and platform strategy.

We have operating leases for most U. 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. We earn a significant amount of our operating income outside the U. As a result, as discussed above under Cash, Cash Equivalents, and Investments, the majority of our cash, cash equivalents, and short-term investments are held by foreign subsidiaries.

We currently do not intend nor foresee a need to repatriate these funds. We expect existing domestic cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities, such as regular quarterly dividends, debt maturities, and material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future.

In addition, we expect existing foreign cash, cash equivalents, short-term investments, and cash flows from operations to continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities, such as material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future. Should we require more capital in the U. These alternatives could result in higher effective tax rates, increased interest expense, or dilution of our earnings.

We have borrowed funds domestically and continue to believe we have the ability to do so at reasonable interest rates. Our consolidated financial statements and accompanying notes are prepared in accordance with U. Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses.

Critical accounting policies for us include revenue recognition, impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and inventories. Revenue recognition for multiple-element arrangements requires judgment to determine if multiple elements exist, whether elements can be accounted for as separate units of accounting, and if so, the fair value for each of the elements.

Judgment is also required to assess whether future releases of certain software represent new products or upgrades and enhancements to existing products. Certain volume licensing arrangements include a perpetual license for current products combined with rights to receive unspecified future versions of software products and are accounted for as subscriptions, with billings recorded as unearned revenue and recognized as revenue ratably over the coverage period.

Software updates are evaluated on a case-by-case basis to determine whether they meet the definition of an upgrade, which may require revenue to be deferred and recognized when the upgrade is delivered.

If updates are determined to not meet the definition of an upgrade, revenue is generally recognized as products are shipped or made available. Microsoft enters into arrangements that can include various combinations of software, services, and hardware.

Where elements are delivered over different periods of time, and when allowed under U. GAAP, revenue is allocated to the respective elements based on their relative selling prices at the inception of the arrangement, and revenue is recognized as each element is delivered. For software elements, we follow the industry-specific software guidance which only allows for the use of VSOE in establishing fair value.

Generally, VSOE is the price charged when the deliverable is sold separately or the price established by management for a product that is not yet sold if it is probable that the price will not change before introduction into the marketplace. ESPs are established as best estimates of what the selling prices would be if the deliverables were sold regularly on a stand-alone basis.

Our process for determining ESPs requires judgment and considers multiple factors that may vary over time depending upon the unique facts and circumstances related to each deliverable.

In January , we announced Windows 10 would be free to all qualified existing users of Windows 7 and Windows 8. This offer differs from historical offers preceding the launch of new versions of Windows as it is being made available for free to existing users in addition to new customers after the offer announcement.

We evaluated the nature and accounting treatment of the Windows 10 offer and determined that it represents a marketing and promotional activity, in part because the offer is being made available for free to existing users.

As this is a marketing and promotional activity, revenue recognition of new sales of Windows 8 will continue to be recognized as delivered. Customers purchasing a Windows 10 license will receive unspecified updates and upgrades over the life of their Windows 10 device at no additional cost.

As these updates and upgrades will not be sold on a stand-alone basis, we are unable to establish VSOE. Accordingly, revenue from licenses of Windows 10 is recognized ratably over the estimated life of the related device, which ranges between two to four years. We currently are evaluating the impact of the new standard related to revenue recognition, which we anticipate will have a material impact on our consolidated financial statements.

We review investments quarterly for indicators of other-than-temporary impairment. This determination requires significant judgment. In making this judgment, we employ a systematic methodology quarterly that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, the duration and extent to which the fair value is less than cost, and for equity securities, our intent and ability to hold, or plans to sell, the investment.

For fixed-income securities, we also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security before recovery. We also consider specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors.

Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded to other income expense , net and a new cost basis in the investment is established. 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. Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product.

Once technological feasibility is established, all software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established. We have determined that technological feasibility for our software products is reached after all high-risk development issues have been resolved through coding and testing.

Generally, this occurs shortly before the products are released to manufacturing. The amortization of these costs is included in cost of revenue over the estimated life of the products. 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. 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.

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 on our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements. Inventories are stated at average cost, subject to the lower of cost or market.

Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories. We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.

Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets.

These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits. The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting.

Frank H. We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, equity prices, and commodity prices. A portion of these risks is hedged, but they may impact our consolidated financial statements. Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk.

We monitor our foreign currency exposures daily and use hedges where practicable to offset the risks and maximize the economic effectiveness of our foreign currency positions. Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar.

Our fixed-income portfolio is diversified across credit sectors and maturities, consisting primarily of investment-grade securities. The credit risk and average maturity of the fixed-income portfolio is managed to achieve economic returns that correlate to certain global and domestic fixed-income indices.

Our equity portfolio consists of global, developed, and emerging market securities that are subject to market price risk. We manage the securities relative to certain global and domestic indices and expect their economic risk and return to correlate with these indices.

We use broad-based commodity exposures to enhance portfolio returns and facilitate portfolio diversification. Our investment portfolio has exposure to a variety of commodities, including precious metals, energy, and grain. We manage these exposures relative to global commodity indices and expect their economic risk and return to correlate with these indices. VaR is the expected loss, for a given confidence level, in the fair value of our portfolio due to adverse market movements over a defined time horizon.

The VaR model is not intended to represent actual losses in fair value, including determinations of other-than-temporary losses in fair value in accordance with U.

GAAP, but is used as a risk estimation and management tool. The distribution of the potential changes in total market value of all holdings is computed based on the historical volatilities and correlations among foreign exchange rates, interest rates, equity prices, and commodity prices, assuming normal market conditions. The VaR is calculated as the total loss that will not be exceeded at the Several risk factors are not captured in the model, including liquidity risk, operational risk, and legal risk.

The following table sets forth the one-day VaR for substantially all of our positions as of June 30, and and for the year ended June 30, We have recast certain prior period amounts to conform to the current period presentation, with no impact on consolidated net income or cash flows. The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Investments through which we are not able to exercise significant influence over the investee and which do not have readily determinable fair values are accounted for under the cost method.

As a result, beginning in fiscal year , we report our financial performance based on our new segments described in Note 21 — Segment Information and Geographic Data.

We have recast certain prior period amounts to conform to the way we internally manage and monitor segment performance during fiscal year This change primarily impacted Note 10 — Goodwill, Note 15 — Unearned Revenue, and Note 21 — Segment Information and Geographic Data, with no impact on consolidated net income or cash flows.

Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Examples of assumptions include: the elements comprising a software arrangement, including the distinction between upgrades or enhancements and new products; when technological feasibility is achieved for our products; the potential outcome of future tax consequences of events that have been recognized on our consolidated financial statements or tax returns; and determining when investment impairments are other-than-temporary.

Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and expenses are translated at average rates of exchange prevailing during the year. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is probable.

Revenue generally is recognized net of allowances for returns and any taxes collected from customers and subsequently remitted to governmental authorities. For software elements, we follow the industry specific software guidance which only allows for the use of VSOE in establishing fair value. Technology guarantee programs are accounted for as multiple-element arrangements as customers receive free or significantly discounted rights to use upcoming new versions of a software product if they license existing versions of the product during the eligibility period.

Revenue is allocated between the existing product and the new product, and revenue allocated to the new product is deferred until that version is delivered. The revenue allocation is based on the VSOE of fair value of the products. The VSOE of fair value for upcoming new products are based on the price determined by management having the relevant authority when the element is not yet sold separately, but is expected to be sold in the near future at the price set by management.

As these updates and upgrades will not be sold on a stand-alone basis, we are unable to establish VSOE of fair value. Certain volume licensing arrangements include a perpetual license for current products combined with rights to receive unspecified future versions of software products, which we have determined are additional software products and are therefore accounted for as subscriptions, with billings recorded as unearned revenue and recognized as revenue ratably over the coverage period.

Arrangements that include term-based licenses for current products with the right to use unspecified future versions of the software during the coverage period, are also accounted for as subscriptions, with revenue recognized ratably over the coverage period.

Revenue from cloud-based services arrangements that allow for the use of a hosted software product or service over a contractually determined period of time without taking possession of software are accounted for as subscriptions with billings recorded as unearned revenue and recognized as revenue ratably over the coverage period beginning on the date the service is made available to customers.

Revenue from cloud-based services arrangements that are provided on a consumption basis for example, the amount of storage used in a particular period is recognized commensurate with the customer utilization of such resources. Some volume licensing arrangements include time-based subscriptions for cloud-based services and software offerings that are accounted for as subscriptions.

These arrangements are considered multiple-element arrangements. However, because all elements are accounted for as subscriptions and have the same coverage period and delivery pattern, they have the same revenue recognition timing. Revenue related to licensing for games published by third parties for use on the Xbox consoles is recognized when games are manufactured by the game publishers.

Display advertising revenue is recognized as advertisements are displayed. Search advertising revenue is recognized when the ad appears in the search results or when the action necessary to earn the revenue has been completed.

Consulting services revenue is recognized as services are rendered, generally based on the negotiated hourly rate in the consulting arrangement and the number of hours worked during the period. Consulting revenue for fixed-price services arrangements is recognized as services are provided. Cost of revenue includes: manufacturing and distribution costs for products sold and programs licensed; operating costs related to product support service centers and product distribution centers; costs incurred to include software on PCs sold by OEMs, to drive traffic to our websites, and to acquire online advertising space; costs incurred to support and maintain Internet-based products and services, including datacenter costs and royalties; warranty costs; inventory valuation adjustments; costs associated with the delivery of consulting services; and the amortization of capitalized software development costs.

Capitalized software development costs are amortized over the estimated lives of the products. We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the related revenue is recognized.

For hardware warranties, we estimate the costs based on historical and projected product failure rates, historical and projected repair costs, and knowledge of specific product failures if any. The specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we do business, but generally include parts and labor over a period generally ranging from 90 days to three years.

For software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary.

Research and development expenses also include third-party development and programming costs, localization costs incurred to translate software for international markets, and the amortization of purchased software code and services content. Such costs related to software development are included in research and development expense until the point that technological feasibility is reached, which for our software products, is generally shortly before the products are released to manufacturing.

Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the estimated lives of the products. Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Compensation cost for stock awards is measured at the fair value on the grant date and recognized as expense, net of estimated forfeitures, over the related service period using the straight-line method.

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Microsoft has an incredibly engaged gaming audience on Xbox Live with 49 million monthly users and growing — up 33 percent year-over-year. This growth is driven in part by strong franchises like Minecraft, which has sold more than million copies to date. In fact, Xbox Live players of Minecraft increased 62 percent in the last year.

Our gaming roadmap over the next 18 months is anchored by two significant console releases — Xbox One S and Project Scorpio — and investments in growth areas such as virtual reality, video, and eSports. We continue to grow the Windows ecosystem by creating new computing categories. Surface, Surface Hub, and Microsoft HoloLens have pushed the boundaries of how personal the computing experience can be, with Surface Book and Surface Pro 4 released in the last year.

Forward-looking customers like Rolls Royce, the PGA Tour, Japan Airlines, and Volvo already are embracing Microsoft HoloLens and the Windows Holographic platform, transforming the way they work by breaking down the barriers between virtual and physical reality. We are excited about these future growth areas but are also committed to ensuring that we are investing thoughtfully across our portfolio. Over the past fiscal year, we increased investment in key capabilities within Windows 10 and in new growth markets, while at the same time scaling back our investment commensurate with the opportunity in areas like phone.

Across each of these ambitions, Microsoft made significant progress this past year. Earlier in this letter I described the transformational opportunities that lie ahead, particularly in the realm of digital intelligence.

Its realization will bring new power to cure disease and address global challenges like climate change. And that brings us right back to our mission — to empower every person and every organization on the planet to achieve more. Last year I concluded this letter committing that we would continue to ask ourselves what are the challenges humankind faces, how can technology help, and what is the contribution of Microsoft?

To me, these questions are essential to the rediscovery of the soul of Microsoft, and more broadly, the purpose of global companies in society. With worldwide per capita GDP and productivity growth at roughly 1 percent, how do we return to vigorous growth that benefits everyone?

When I meet with leaders in every part of the world, I hear their desire to work with Microsoft to create world class, cloud-enabled platforms, and applications that advance health, education, and economic growth, locally in their countries and communities.

That is what inspires me most. Throughout our discussions with LinkedIn this year, I was struck in my conversations with founder Reid Hoffman and CEO Jeff Weiner that we share a commitment to more directly and more evenly spread opportunity for everyone. The goal is to make labor markets work better for everyone by making them more efficient and open. Together we aspire to help everyone navigate an increasingly challenging global economy more effectively.

In conclusion, the test of any brand is its ability to have measurable impact and to remain relevant over time. Microsoft has done this in times of transition by innovating boldly.

When I walk the hallways of Microsoft and talk with our talented people, the sense of purpose and urgency in realizing our mission through world class innovation is unmistakable. Non-GAAP results exclude the net impact from Windows 10 revenue deferrals and the impact of impairment, integration, and restructuring expenses. On July 25, , there were , registered holders of record of our common stock.

The high and low common stock sales prices per share were as follows:. The share repurchase program became effective on October 1, , has no expiration date, and may be suspended or discontinued at any time without notice. This share repurchase program replaced the share repurchase program that was announced on September 22, and expired on September 30, All repurchases were made using cash resources.

The above table excludes shares repurchased to settle statutory employee tax withholding related to the vesting of stock awards. The dividend declared on June 14, will be paid after the filing of our Form K and was included in other current liabilities as of June 30, The dividend declared on June 9, was included in other current liabilities as of June 30, 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 undertake no obligation to update or revise publicly any forward-looking statements, whether because of new information, future events, or otherwise.

Microsoft is a technology company whose mission is to empower every person and every organization on the planet to achieve more. Our strategy is to build best-in-class platforms and productivity services for a mobile-first, cloud-first world. The mobile-first, cloud-first world is transforming the way individuals and organizations use and interact with technology.

Mobility is not focused on any one device; it is centered on the mobility of experiences that, in turn, are orchestrated by the cloud. Cloud computing and storage solutions provide people and enterprises with various capabilities to store and process their data in third-party datacenters. Mobility encompasses the rich collection of data, applications, and services that accompany our customers as they move from setting to setting in their lives.

We are transforming our businesses to enable Microsoft to lead the direction of this digital transformation, and enable our customers and partners to thrive in this evolving world. Founded in , we operate worldwide in over countries. Our products include operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; video games; and training and certification of computer system integrators and developers.

We also design, manufacture, and sell devices, including PCs, tablets, gaming and entertainment consoles, phones, other intelligent devices, and related accessories, that integrate with our cloud-based offerings. We offer an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and we provide solution support and consulting services.

We also deliver relevant online advertising to a global audience. To carry out our strategy, our research and development efforts focus on three interconnected ambitions:.

We believe we can significantly enhance the lives of our customers using our broad portfolio of productivity, communication, and information services that span devices and platforms. Productivity will be the first and foremost objective, to enable people to meet and collaborate more easily, and to effectively express ideas in new ways. With Office , we provide these familiar industry-leading productivity and business process tools as cloud services, enabling access from anywhere and any device.

This creates an opportunity to reach new customers and expand the usage of our services by our existing customers. We see opportunity in combining our offerings in new ways that are mobile, collaborative, intelligent and trustworthy. We offer our services across platforms and devices outside our own. As people move from device to device, so will their content and the richness of their services. We engineer our applications so users can find, try, and buy them in friction-free ways.

In deploying technology that advances business strategy, enterprises decide what solutions will make employees more productive, collaborative, and satisfied, and connect with customers in new and compelling ways. They work to unlock business insights from a world of data.

To achieve these objectives, increasingly businesses look to leverage the benefits of the cloud. Helping businesses move to the cloud is one of our largest opportunities, and we believe we work from a position of strength. Microsoft is one of two leaders in the market. The shift to the cloud is driven by three important economies of scale: larger datacenters can deploy computational resources at significantly lower cost per unit than smaller ones; larger datacenters can coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources; and multi-tenancy lowers application maintenance labor costs for large public clouds.

As one of the largest providers of cloud computing at scale, we are well-positioned to help businesses move to the cloud and focus on innovation while leaving non-differentiating activities to reliable and cost-effective providers like Microsoft. With Azure, we are one of very few cloud vendors that run at a scale that meets the needs of businesses of all sizes and complexities.

We are working to enhance the return on IT investment by enabling enterprises to combine their existing datacenters and our public cloud into a single cohesive infrastructure.

We enable organizations to securely adopt software-as-a-service applications, both our own and third-party, and integrate them with their existing security and management infrastructure. We continue to innovate with higher-level services including identity and directory services that manage employee corporate identity and manage and secure corporate information accessed and stored across a growing number of devices, rich data storage and analytics services, machine learning services, media services, web and mobile backend services, and developer productivity services.

To foster a rich developer ecosystem, our platform is extensible, enabling customers and partners to further customize and enhance our solutions, achieving even more value. This strategy requires continuing investment in datacenters and other infrastructure to support our services.

We strive to make computing more personal by putting users at the core of the experience, enabling them to interact with technology in more intuitive, engaging, and dynamic ways. A computing device should be not just a tool, but a partner.

Windows 10 is the cornerstone of our ambition to usher in this era of more personal computing. We consider the launch of Windows 10 in July to be a transformative moment as we moved from an operating system that runs on a PC to a service that can power the full spectrum of devices.

We developed Windows 10 not only to be familiar to our users, but more safe, secure, and always up-to-date. Windows 10 is more personal and productive with functionality such as Cortana, Windows Hello, Windows Ink, Microsoft Edge, and universal applications. Windows 10 is designed to foster innovation — from us, our partners, and developers — through rich and consistent experiences across the range of existing devices and entirely new device categories.

Our OEM partners are investing in an extensive portfolio of hardware designs and configurations for Windows We now have the widest range of Windows hardware ever available. With the unified Windows operating system, developers and OEMs can contribute to a thriving Windows ecosystem. We invest heavily to make Windows the most secure, manageable, and capable operating system for the needs of a modern workforce.

We are working to create a broad developer opportunity by unifying the installed base to Windows 10 through upgrades and ongoing updates, and by enabling universal Windows applications to run across all device targets. As part of our strategic objectives, we are committed to designing and marketing first-party devices to help drive innovation, create new categories, and stimulate demand in the Windows ecosystem.

There are several distinct areas of technology that we aim to drive forward. Our goal is to lead the industry in these areas over the long-term, which we expect will translate to sustained growth. We are investing significant resources in:. We believe the breadth of our products and services portfolio, our large global partner and customer base, our growing ecosystem, and our ongoing investment in innovation position us to be a leader in these areas and differentiate ourselves from competitors.

Our segments provide management with a comprehensive financial view of our key businesses. The segments enable the alignment of strategies and objectives across the development, sales, marketing, and services organizations, and they provide a framework for timely and rational allocation of resources within businesses.

In June , we announced a change in organizational structure to align to our strategic direction as a productivity and platform company. During the first quarter of fiscal year , our chief operating decision maker, who is also our Chief Executive Officer, requested changes in the information that he regularly reviews for purposes of allocating resources and assessing performance. As a result, beginning in fiscal year , we report our financial performance based on our new segments, Productivity and Business Processes, Intelligent Cloud, and More Personal Computing.

Additional information on our operating segments and geographic and product information is contained in Note 21 — Segment Information and Geographic Data of the Notes to Financial Statements. Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms.

This segment primarily comprises:. Office Commercial is designed to increase personal, team, and organizational productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service offerings into new markets such as security, analytics, collaboration, unified communications, and business intelligence.

Office Commercial revenue is mainly affected by a combination of the demand from commercial customers for volume licensing and Software Assurance and the number of information workers in an enterprise, as well as the continued shift to Office Office is our cloud-based service that provides access to Office plus other productivity services. CALs provide access rights to certain Office Commercial products and services, including Exchange, SharePoint, and Skype for Business, and revenue is reported along with the associated Office products and services.

Office Consumer is designed to increase personal productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service offerings into new markets.

Office Consumer revenue is mainly affected by the combination of customers that buy Office with their new devices and the continued shift to Office Office Consumer Services revenue is mainly affected by the demand for communication and storage through Skype, Outlook. Skype is designed to connect friends, family, clients, and colleagues through a variety of devices. Dynamics revenue is largely driven by the number of information workers licensed. Cisco Systems is using its position in enterprise communications equipment to grow its unified communications business.

Google provides a hosted messaging and productivity suite. Apple distributes versions of its pre-installed application software, such as email, note-taking, and calendar products, through its PCs, tablets, and phones. Skype for Business and Skype also compete with a variety of instant messaging, voice, and video communication providers, ranging from start-ups to established enterprises.

Web-based offerings competing with individual applications have also positioned themselves as alternatives to our products. We believe our products compete effectively based on our strategy of providing powerful, flexible, secure, and easy-to-use solutions that work well with technologies our customers already have and are available on a device or via the cloud.

Our Dynamics products compete with vendors such as Oracle and SAP in the market for large organizations and divisions of global enterprises.

In the market focused on providing solutions for small and mid-sized businesses, our Dynamics products compete with vendors such as Infor, The Sage Group, and NetSuite.

Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business.

Our server products are designed to make IT professionals, developers, and their systems more productive and efficient. Server software is integrated server infrastructure and middleware designed to support software applications built on the Windows Server operating system.

This includes the server platform, database, business intelligence, storage, management and operations, virtualization, service-oriented architecture platform, security, and identity software. We also license standalone and software development lifecycle tools for software architects, developers, testers, and project managers. Server products and cloud services revenue is mainly affected by purchases through volume licensing programs, licenses sold to OEMs, and retail packaged products.

CALs provide access rights to certain server products, including SQL Server and Windows Server, and revenue is reported along with the associated server product. Azure is a scalable cloud platform with computing, networking, storage, database, and management, along with advanced services such as analytics, and comprehensive solutions such as Enterprise Mobility Suite.

Azure includes a flexible platform that helps developers build, deploy, and manage enterprise, mobile, web, and Internet of Things applications, for any platform or device without having to worry about the underlying infrastructure. Azure enables customers to devote more resources to development and use of applications that benefit their organizations, rather than managing on-premises hardware and software.

Enterprise Services, including Premier Support Services and Microsoft Consulting Services, assist customers in developing, deploying, and managing Microsoft server and desktop solutions and provide training and certification to developers and IT professionals on various Microsoft products.

Our server products face competition from a wide variety of server operating systems and applications offered by companies with a range of market approaches.

Vertically integrated computer manufacturers such as Hewlett-Packard, IBM, and Oracle offer their own versions of the Unix operating system preinstalled on server hardware.

Nearly all computer manufacturers offer server hardware for the Linux operating system and many contribute to Linux operating system development. The competitive position of Linux has also benefited from the large number of compatible applications now produced by many commercial and non-commercial software developers. A number of companies, such as Red Hat, supply versions of Linux.

We compete to provide enterprise-wide computing solutions and point solutions with numerous commercial software vendors that offer solutions and middleware technology platforms, software applications for connectivity both Internet and intranet , security, hosting, database, and e-business servers.

IBM and Oracle lead a group of companies focused on the Java Platform Enterprise Edition that competes with our enterprise-wide computing solutions. In middleware, we compete against Java vendors. Our database, business intelligence, and data warehousing solutions offerings compete with products from IBM, Oracle, SAP, and other companies. We believe our server products provide customers with advantages in performance, total costs of ownership, and productivity by delivering superior applications, development tools, compatibility with a broad base of hardware and software applications, security, and manageability.

Our Enterprise Services business competes with a wide range of companies that provide strategy and business planning, application development, and infrastructure services, including multinational consulting firms and small niche businesses focused on specific technologies. Our More Personal Computing segment consists of products and services geared towards harmonizing the interests of end users, developers, and IT professionals across screens of all sizes.

The Windows operating system is designed to deliver a more personal computing experience for users by enabling consistency of experience, applications, and information across their devices. Windows revenue is impacted significantly by the number of Windows operating system licenses purchased by OEMs, which they pre-install on the devices they sell.

In addition to computing device market volume, Windows revenue is impacted by:. Volume licensing of the Windows operating system is affected mainly by the demand from commercial customers for volume licensing and Software Assurance, often reflecting the number of information workers in a licensed enterprise, and is therefore relatively independent of the number of PCs sold in a given year. Patent licensing includes our programs to license patents across a broad array of technology areas, including mobile devices and cloud offerings.

Windows Embedded extends the power of Windows and the cloud to intelligent systems by delivering specialized operating systems, tools, and services. Display advertising primarily includes MSN ads. The Windows Phone operating system is designed to bring users closer to the people, applications, and content they need. We design, manufacture, and sell devices such as Surface, phones, and other intelligent devices, as well as PC accessories.

Our devices are designed to enable people and organizations to connect to the people and content that matter most using integrated Microsoft services and Windows. Surface is designed to help organizations, students, and consumers to be more productive. In July , we announced a plan to restructure our phone business to better focus and align resources. In May , we announced plans to further streamline our smartphone hardware business. We also recently announced the sale of our entry-level feature phone business in May The transaction is expected to close in the second half of , subject to regulatory approvals and other closing conditions.

Our gaming platform is designed to provide a unique variety of entertainment through the use of our devices, peripherals, applications, online services, and content. We also launched our Windows 10 Xbox app in July Xbox Live enables people to connect and share online gaming experiences and is accessible on Xbox consoles, Windows-enabled devices, and other devices.

Xbox Live services consist of subscriptions and sales of Xbox Live enabled content, as well as advertising, and are designed to benefit users by providing access to a network of certified applications and services and to benefit our developer and partner ecosystems by providing access to a large customer base. We also design and sell gaming content to showcase our unique platform capabilities for Xbox consoles, Windows-enabled devices, and other devices.

The addition of Minecraft and its community enhances our gaming portfolio across Windows, Xbox, and other ecosystems besides our own.

We believe the success of our gaming business is determined by the overall active user base through Xbox Live enabled content, availability of games, providing exclusive game content that gamers seek, the computational power and reliability of the devices used to access our content and services, and the ability to create new experiences via online services, downloadable content, and peripherals.

Search advertising, including Bing and Bing Ads, is designed to deliver relevant online advertising to a global audience. We have several partnerships with other companies, including Yahoo! Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser offerings.

The Windows operating system faces competition from various software products and from alternative platforms and devices, mainly from Apple and Google. We believe Windows competes effectively by giving customers choice, value, flexibility, security, an easy-to-use interface, and compatibility with a broad range of hardware and software applications, including those that enable productivity. Our devices face competition from various computer, tablet, hardware, and phone manufacturers, and offer a unique combination of high-quality industrial design and innovative technologies across various price points, many of which are also current or potential partners and customers.

Our gaming platform competes with console platforms from Sony and Nintendo, both of which have a large, established base of customers. The lifecycle for gaming and entertainment consoles averages five to ten years. Nintendo released their latest generation console in November Sony released their latest generation console in November In addition to Sony and Nintendo, we compete with other providers of entertainment services through online marketplaces.

We believe our gaming platform is effectively positioned against competitive products and services based on significant innovation in hardware architecture, user interface, developer tools, online gaming and entertainment services, and continued strong exclusive content from our own game franchises as well as other digital content offerings.

Our video games competitors include Electronic Arts and Activision Blizzard. Xbox Live faces competition from various online marketplaces, including those operated by Amazon, Apple, and Google.

Our search advertising business competes with Google and a wide array of websites, social platforms like Facebook, and portals that provide content and online offerings to end users.

We have operations centers that support all operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics.

In addition to the operations centers, we also operate datacenters throughout the Americas, Australia, Europe, and Asia. To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we localize many of our products to reflect local languages and conventions.

Localizing a product may require modifying the user interface, altering dialog boxes, and translating text. We operate manufacturing facilities for the production and customization of phones, predominantly in Vietnam. We announced the sale of our entry-level feature phone business in May , which includes the sale of our phone manufacturing facility in Vietnam. Our devices, other than phones, are primarily manufactured by third-party contract manufacturers. We generally have the ability to use other manufacturers if a current vendor becomes unavailable or unable to meet our requirements.

We plan to continue to make significant investments in a broad range of research and development efforts. Internal development allows us to maintain competitive advantages that come from product differentiation and closer technical control over our products and services.

It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented. We strive to obtain information as early as possible about changing usage patterns and hardware advances that may affect software design.

Before releasing new software platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing. Generally, we also create product documentation internally. We protect our intellectual property investments in a variety of ways. We work actively in the U. We are a leader among technology companies in pursuing patents and currently have a portfolio of over 61, U.

From time to time, we enter into broader cross-license agreements with other technology companies covering entire groups of patents. We also purchase or license technology that we incorporate into our products or services.

At times, we make select intellectual property broadly available at no or low cost to achieve a strategic objective, such as promoting industry standards, advancing interoperability, or attracting and enabling our external development community. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products and business methods, we believe, based upon past experience and industry practice, such licenses generally could be obtained on commercially reasonable terms.

We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products. We invest in a range of emerging technology trends and breakthroughs that we believe offer significant opportunities to deliver value to our customers and growth for the company.

Based on our assessment of key technology trends, we maintain our long-term commitment to research and development across a wide spectrum of technologies, tools, and platforms spanning digital work and life experiences, cloud computing, and devices operating systems and hardware. While our main research and development facilities are located in Redmond, Washington, we also operate research and development facilities in other parts of the U. This global approach helps us remain competitive in local markets and enables us to continue to attract top talent from across the world.

We generally fund research at the corporate level to ensure that we are looking beyond immediate product considerations to opportunities further in the future. We also fund research and development activities at the business segment level. Much of our business segment level research and development is coordinated with other segments and leveraged across the company.

In addition to our main research and development operations, we also operate Microsoft Research. We market and distribute our products and services through the following channels: OEMs, distributors and resellers, online, and Microsoft retail stores.

Our sales force performs a variety of functions, including working directly with enterprises and public sector organizations worldwide to identify and meet their software requirements; managing OEM relationships; and supporting solution integrators, independent software vendors, and other partners who engage directly with our customers to perform sales, consulting, and fulfillment functions for our products. We distribute software through OEMs that pre-install our software on new devices and servers they sell.

The largest component of the OEM business is the Windows operating system pre-installed on computing devices. OEMs also sell hardware pre-installed with other Microsoft products, including server and embedded operating systems and applications such as our Microsoft Office suite. In addition to these products, we also market our services through OEMs and service bundles such as Windows with Bing or Windows with Office subscription.

There are two broad categories of OEMs. Although each type of reselling partner reaches organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small- and medium-sized organizations. Our Dynamics software offerings are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services.

We distribute our retail packaged products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets. Individual consumers obtain these products primarily through retail outlets, including Microsoft retail stores. We distribute our devices through third-party retailers and Microsoft retail stores. Our phones are also distributed through global wireless communications carriers.

We have a network of field sales representatives and field support personnel that solicit orders from distributors and resellers, and provide product training and sales support.

Although on-premises software continues to be an important part of our business, increasingly we are delivering additional value to customers through cloud-based services. Other services delivered online include our online advertising platform with offerings for advertisers and publishers, as well as Microsoft Developer Network subscription content and updates, periodic product updates, and online technical and practice readiness resources to support our partners in developing and selling our products and solutions.

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