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, 2019
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  

WASHINGTON 91-1144442
(STATE OF INCORPORATION) (I.R.S. ID)
ONE MICROSOFT WAY, REDMOND, WASHINGTON 98052-6399
(425) 882-8080
www.microsoft.com/investor
Securities registered pursuant to Section 12(b) of the Act:  

Title of each class Trading Symbol Name of exchange on which registered

Common stock, $0.00000625 par value per share MSFT NASDAQ
2.125% Notes due 2021 MSFT NASDAQ
3.125% Notes due 2028 MSFT NASDAQ
2.625% Notes due 2033 MSFT NASDAQ
Securities registered pursuant to Section 12(g) of the Act:
NONE
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 every Interactive Data File required to be submitted 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 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 ☒   Accelerated filer ☐

Non-accelerated filer ☐   Smaller reporting company ☐
Emerging growth company ☐
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   Outstanding as of January 24, 2020 
 
 

Common Stock, $0.00000625 par value per share    7,606,047,010 shares  

 
 
 MICROSOFT CORPORATION
FORM 10-Q
For the Quarter Ended December 31, 2019
INDEX
 
Page
PART I. FINANCIAL INFORMATION
 
  Item 1. Financial Statements
 
    a) Income Statements for the Three and Six Months Ended December 31, 2019 and 2018 3
 
b) Comprehensive Income Statements for the Three and Six Months Ended December 31,
2019 and 2018 4
 
c) Balance Sheets as of December 31, 2019 and June 30, 2019 5
 
d) Cash Flows Statements for the Three and Six Months Ended December 31, 2019
and 2018 6
 
e) Stockholders’ Equity Statements for the Three and Six Months Ended December 31,
2019 and 2018 7
 
f) Notes to Financial Statements 8
 
g) Report of Independent Registered Public Accounting Firm 30
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 31
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk 45
 
Item 4. Controls and Procedures 45
 
PART II. OTHER INFORMATION
 
Item 1. Legal Proceedings 46
 
Item 1A. Risk Factors 46
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 57
 
Item 6. Exhibits 58
 
SIGNATURE 59

2
 PART I
Item 1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
INCOME STATEMENTS

Three Months Ended Six Months Ended
(In millions, except per share amounts) (Unaudited) December 31, December 31,
 
 
2019    2018 2019 2018
 

Revenue:  
Product $ 18,255   $ 16,219  $ 34,023 $ 33,518
Service and other 18,651 16,252 35,938 28,037
   
  
Total revenue    36,906      32,471  69,961  61,555 
   

Cost of revenue:       
Product 4,966    5,885  8,271  9,534
Service and other 7,392 6,538 14,493 12,794
   
  
Total cost of revenue    12,358      12,423  22,764    22,328 
   

Gross margin    24,548      20,048  47,197 39,227

Research and development    4,603      4,070  9,168 8,047
Sales and marketing    4,933      4,588  9,270 8,686
General and administrative    1,121      1,132  2,182 2,281
   

Operating income    13,891      10,258  26,577  20,213

Other income, net    194      127  194 393
   

Income before income taxes    14,085      10,385  26,771  20,606

Provision for income taxes    2,436      1,965  4,444  3,362
   

Net income  $ 11,649   $ 8,420 $ 22,327 $ 17,244

 
         

Earnings per share:      

Basic  $ 1.53   $ 1.09 $ 2.93 $ 2.24
Diluted  $ 1.51   $ 1.08 $ 2.90 $ 2.22

Weighted average shares outstanding:         

Basic    7,621      7,692  7,628  7,683
Diluted    7,691      7,768  7,701  7,767
   

 Refer to accompanying notes.

3
 PART I
Item 1

COMPREHENSIVE INCOME STATEMENTS

 
Three Months Ended Six Months Ended
(In millions) (Unaudited) December 31, December 31,
 
 
  2019    2018  2019 2018
 

Net income   $ 11,649   $ 8,420 $ 22,327  $ 17,244

 
 

Other comprehensive income (loss), net of tax:                

Net change related to derivatives    (4)     (15) (6) (60)

Net change related to investments    (420)     881 157 620
Translation adjustments and other    230     (264) (66) (319)
 
 

Other comprehensive income (loss)     (194)     602 85 241

 
 

Comprehensive income   $ 11,455   $ 9,022 $ 22,412 $ 17,485

 

Refer to accompanying notes.

4
 PART I
Item 1

BALANCE SHEETS
 
(In millions) (Unaudited)      
 
 
December 31, June 30,
  2019    2019  
 

Assets               

Current assets:               

Cash and cash equivalents   $ 8,864   $ 11,356 

Short-term investments     125,389     122,463 
 
      

Total cash, cash equivalents, and short-term investments     134,253     133,819 

Accounts receivable, net of allowance for doubtful accounts of $384 and
$411   23,525     29,524 
 
Inventories     1,823     2,063 
Other current assets     7,473     10,146 
 
      

Total current assets     167,074     175,552 

Property and equipment, net of accumulated depreciation of $39,597 and
$35,330     40,522     36,477 
Operating lease right-of-use assets 8,439 7,379
Equity investments     2,755     2,649 
Goodwill     42,248     42,026 
Intangible assets, net     7,126     7,750 
Other long-term assets     14,630     14,723 
 
      

Total assets   $ 282,794   $ 286,556 

 
            

Liabilities and stockholders’ equity               

Current liabilities:               

Accounts payable   $ 8,811   $ 9,382 

Current portion of long-term debt 6,247 5,516
Accrued compensation     5,421     6,830 
Short-term income taxes     2,687     5,665 
Short-term unearned revenue     27,343     32,676 
Other current liabilities     9,131     9,351 
 
      

Total current liabilities     59,640     69,420 

Long-term debt     63,361     66,662 
Long-term income taxes 28,754 29,612
Long-term unearned revenue     3,878     4,530 
Deferred income taxes     222     233 
Operating lease liabilities 7,172 6,188
Other long-term liabilities     9,658     7,581 
 
      

Total liabilities     172,685     184,226 

 
      

Commitments and contingencies               

Stockholders’ equity:               

Common stock and paid-in capital – shares authorized 24,000; outstanding

7,611 and 7,643     79,625     78,520 
Retained earnings     30,739     24,150 
Accumulated other comprehensive loss     (255)    (340)
 
      

Total stockholders’ equity     110,109     102,330 

 
      

Total liabilities and stockholders’ equity   $ 282,794   $ 286,556 

            

Refer to accompanying notes.

5
 PART I
Item 1

CASH FLOWS STATEMENTS

Three Months Ended Six Months Ended
(In millions) (Unaudited) December 31,  December 31,
 
 
  2019    2018  2019 2018
 

Operations                

Net income   $ 11,649   $ 8,420 $ 22,327 $ 17,244

Adjustments to reconcile net income to net cash from
operations:            

Depreciation, amortization, and other     3,203     2,995 6,174  5,832 

Stock-based compensation expense     1,340     1,183 2,602  2,290 
Net recognized gains on investments and derivatives     (203)     (135) (192) (375)
Deferred income taxes     (53)     (173) (230) (420)
Changes in operating assets and liabilities:            

Accounts receivable     (4,203)     (2,396) 5,887  6,798 

Inventories     799 1,654 238 698
Other current assets     165     (173) (273) (850)
Other long-term assets     (517)     (473) (850) (452)
Accounts payable     (7)     (440) (554) (835)
Unearned revenue (2,936) (2,122) (5,828) (4,563)
Income taxes (471) (64) (3,807) (1,155)
Other current liabilities     1,489     656 (1,831) (1,666)
Other long-term liabilities     425     (32) 835  11 
 
 

Net cash from operations     10,680     8,900 24,498 22,557

 
 

Financing            

Repayments of debt     (18)     (3,000) (2,518) (3,000)

Common stock issued     234     200 661  560 
Common stock repurchased     (5,206)     (6,413) (10,118) (10,157)
Common stock cash dividends paid     (3,886)     (3,544) (7,396) (6,764)
Other, net     (39)     (459) 247 (1,239)
 
 

Net cash used in financing     (8,915)     (13,216) (19,124) (20,600)

 
 

Investing            

Additions to property and equipment     (3,545)     (3,707) (6,930) (7,309)

Acquisition of companies, net of cash acquired, and
purchases of intangible and other assets     (80)     (1,593) (542) (1,838)
Purchases of investments     (19,011)     (16,858) (42,401) (36,409)
Maturities of investments     11,230     3,782 30,312  8,996 
Sales of investments     5,370     14,176 11,749  29,407 
 
 

Net cash used in investing     (6,036)     (4,200) (7,812) (7,153)

 
 

Effect of foreign exchange rates on cash and cash

equivalents     18     17 (54) (112)
 
 

Net change in cash and cash equivalents     (4,253)     (8,499) (2,492) (5,308)
Cash and cash equivalents, beginning of period     13,117     15,137 11,356 11,946
 
 

Cash and cash equivalents, end of period   $ 8,864   $ 6,638 $ 8,864 $ 6,638
 

Refer to accompanying notes.

6
 PART I
Item 1

STOCKHOLDERS’ EQUITY STATEMENTS

 
Three Months Ended Six Months Ended
(In millions) (Unaudited)   December 31,   December 31,
 
 
  2019    2018  2019 2018
 

Common stock and paid-in capital                

Balance, beginning of period   $ 78,882    $ 71,303  $ 78,520  $ 71,223

Common stock issued     234     5,887  661  6,247
Common stock repurchased     (831)     (828) (2,157) (2,215)
Stock-based compensation expense     1,340     1,183  2,602  2,290
Other, net     0     11 (1) 11
 
   
Balance, end of period     79,625      77,556  79,625  77,556
 
Retained earnings                 

Balance, beginning of period     27,240      17,279  24,150 13,682

Net income     11,649     8,420 22,327  17,244
Common stock cash dividends     (3,875)     (3,546) (7,762) (7,074)
Common stock repurchased     (4,275)     (5,568) (7,976) (7,944)
Cumulative effect of accounting changes 0 0 0 677
 
Balance, end of period     30,739      16,585  30,739  16,585
 
Accumulated other comprehensive income (loss)                 

Balance, beginning of period     (61)     (2,615) (340) (2,187)

Other comprehensive income (loss)     (194)     602 85 241
Cumulative effect of accounting changes 0 0 0 (67)
 
Balance, end of period     (255)     (2,013) (255) (2,013)
 
 
 
Total stockholders’ equity   $ 110,109    $ 92,128  $   110,109  $ 92,128
 

Cash dividends declared per common share $ 0.51 $ 0.46 $ 1.02 $ 0.92
 

Refer to accompanying notes.

7
 PART I
Item 1

NOTES TO FINANCIAL STATEMENTS

(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 fiscal year 2019 Form 10-K filed with the U.S. Securities and
Exchange Commission (“SEC”) on August 1, 2019.

Principles of Consolidation

The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries.
Intercompany transactions and balances have been eliminated.

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 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 uncertain tax
positions that have been recognized in our consolidated financial statements or tax returns; and determining the
timing and amount of impairments for investments. Actual results and outcomes may differ from management’s
estimates and assumptions.

Financial Instruments

Investments

We consider all highly liquid interest-earning investments with a maturity of three months or less at the date of
purchase to be cash equivalents. The fair values of these investments approximate their carrying values. In general,
investments with original maturities of greater than three months and remaining maturities of less than one year are
classified as short-term investments. Investments with maturities beyond one year may be classified as short-term
based on their highly liquid nature and because such marketable securities represent the investment of cash that is
available for current operations.

Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific
identification method. Changes in fair value, excluding other-than-temporary impairments, are recorded in other
comprehensive income. Debt investments are impaired when a decline in fair value is judged to be other-than-
temporary. Fair value is calculated based on publicly available market information or other estimates determined by
management. We employ a systematic methodology on a quarterly basis that considers available quantitative and
qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its
fair value, we evaluate, among other factors, general market conditions, credit quality of debt instrument issuers, and
the duration and extent to which the fair value is less than cost. 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. In addition, we
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 in other
income (expense), net and a new cost basis in the investment is established.

8
 PART I
Item 1

Equity investments with readily determinable fair values are measured at fair value. Equity investments without
readily determinable fair values are measured using the equity method or measured at cost with adjustments for
observable changes in price or impairments (referred to as the measurement alternative). We perform a qualitative
assessment on a quarterly basis and recognize an impairment if there are sufficient indicators that the fair value of
the investment is less than carrying value. Changes in value are recorded in other income (expense), net.

Derivatives

Derivative instruments are recognized as either assets or liabilities and measured at fair value. The accounting for
changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.

For derivative instruments designated as fair value hedges, gains and losses are recognized in other income
(expense), net with offsetting gains and losses on the hedged items. Gains and losses representing hedge
components excluded from the assessment of effectiveness are recognized in other income (expense), net.

For derivative instruments designated as cash flow hedges, gains and losses are initially reported as a component of
other comprehensive income and subsequently recognized in earnings with the corresponding hedged item. Gains
and losses representing hedge components excluded from the assessment of effectiveness are recognized in
earnings.

For derivative instruments that are not designated as hedges, gains and losses from changes in fair values are
primarily recognized in other income (expense), net.

Fair Value Measurements

We account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on
the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair
value measurements in one of these three levels based on the lowest level input that is significant to the fair value
measurement in its entirety. These levels are:
• Level 1 – inputs are based upon unadjusted quoted prices for identical instruments in active markets. Our
Level 1 investments include U.S. government securities, common and preferred stock, and mutual
funds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges.
• Level 2 – inputs are based upon quoted prices for similar instruments in active markets, quoted prices for
identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g.
the Black-Scholes model) for which all significant inputs are observable in the market or can be
corroborated by observable market data for substantially the full term of the assets or liabilities. Where
applicable, these models project future cash flows and discount the future amounts to a present value
using market-based observable inputs including interest rate curves, credit spreads, foreign exchange
rates, and forward and spot prices for currencies. Our Level 2 investments include commercial paper,
certificates of deposit, U.S. agency securities, foreign government bonds, mortgage- and asset-backed
securities, corporate notes and bonds, and municipal securities. Our Level 2 derivative assets and
liabilities primarily include certain over-the-counter option and swap contracts.
• Level 3 – inputs are generally unobservable and typically reflect management’s estimates of assumptions
that market participants would use in pricing the asset or liability. The fair values are therefore determined
using model-based techniques, including option pricing models and discounted cash flow models. Our
Level 3 assets and liabilities include investments in corporate notes and bonds, municipal securities, and
goodwill and intangible assets, when they are recorded at fair value due to an impairment
charge. Unobservable inputs used in the models are significant to the fair values of the assets and
liabilities.

We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of
these investments are determined based on valuation techniques using the best information available, and may
include quoted market prices, market comparables, and discounted cash flow projections.

Our other current financial assets and current financial liabilities have fair values that approximate their carrying
values.

9
 PART I
Item 1

Contract Balances

As of December 31, 2019 and June 30, 2019, long-term accounts receivable, net of allowance for doubtful accounts,
was $2.4 billion and $2.2 billion, respectively, and is included in other long-term assets in our consolidated balance
sheets.

Recent Accounting Guidance

Recently Adopted Accounting Guidance

Financial Instruments – Targeted Improvements to Accounting for Hedging Activities

In August 2017, the Financial Accounting Standards Board (“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. We adopted the standard effective July 1, 2019. As we did not hold derivative instruments requiring an
adjustment upon adoption, there was no impact in our consolidated financial statements. Adoption of the standard
enhanced the presentation of the effects of our hedging instruments and the hedged items in our consolidated
financial statements to increase the understandability of the results of our hedging strategies.

Recent Accounting Guidance Not Yet Adopted

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 adopted upon the effective date for us
beginning July 1, 2020. 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 have evaluated the impact of this standard in our consolidated financial statements, including
accounting policies, processes, and systems, and based on current market conditions, we do not expect the impact
to be material upon adoption.

Accounting for Income Taxes

In December 2019, the FASB issued a new standard to simplify the accounting for income taxes. The guidance
eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating
income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences related to
changes in ownership of equity method investments and foreign subsidiaries. The guidance also simplifies aspects of
accounting for franchise taxes and enacted changes in tax laws or rates, and clarifies the accounting for transactions
that result in a step-up in the tax basis of goodwill. The standard will be effective for us beginning July 1, 2021, with
early adoption permitted. We are currently evaluating the impact of this standard in our consolidated financial
statements, including accounting policies, processes, and systems.

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.

10
 PART I
Item 1

The components of basic and diluted EPS were as follows:

Three Months Ended Six Months Ended
(In millions, except earnings per share)   December 31,  December 31,
 
 
  2019    2018  2019 2018
 

Net income available for common shareholders (A)  $ 11,649    $ 8,420 $   22,327 $ 17,244
 
                 
Weighted average outstanding shares of common stock (B)     7,621      7,692  7,628  7,683
Dilutive effect of stock-based awards    70      76  73 84
 
     
  
   
Common stock and common stock equivalents (C)    7,691      7,768  7,701 7,767
 
             
Earnings Per Share                
 

Basic (A/B)  $ 1.53   $ 1.09 $ 2.93 $ 2.24

Diluted (A/C)  $ 1.51   $ 1.08 $ 2.90 $ 2.22
 

Anti-dilutive stock-based awards excluded from the calculations of diluted EPS were immaterial during the periods
presented.

NOTE 3 — OTHER INCOME (EXPENSE), NET

The components of other income (expense), net were as follows:

Three Months Ended Six Months Ended
(In millions) December 31, December 31,
 
 
  2019    2018  2019 2018
 

Interest and dividends income   $ 688    $ 704  $ 1,412 $ 1,385

Interest expense     (654)     (672) (1,291) (1,346)
Net recognized gains on investments     162      94  105 337
Net gains on derivatives     41     41 87 38
Net losses on foreign currency remeasurements     (24)     (74) (82) (69)
Other, net     (19)     34 (37) 48
   
         

Total   $ 194   $ 127 $ 194 $ 393

             

Net Recognized Gains (Losses) on Investments

Net recognized gains (losses) on debt investments were as follows:

Three Months Ended Six Months Ended
(In millions) December 31, December 31,

2019 2018 2019 2018

Realized gains from sales of available-for-sale securities   $ 14   $ 6 $ 21 $ 13

Realized losses from sales of available-for-sale securities     (6)     (5) (10) (90)
Other-than-temporary impairments of investments     (1)     (7) (5) (7)
 
       
  
Total   $ 7   $ (6) $ 6 $ (84)
             

11
 PART I
Item 1

Net recognized gains (losses) on equity investments were as follows:

Three Months Ended Six Months Ended
(In millions) December 31, December 31,

2019 2018 2019 2018

Net realized gains on investments sold   $ 53   $ 30 $ 75 $ 233

Net unrealized gains on investments still held     111     73 55 191
Impairments of investments     (9)     (3) (31) (3)
 
       

Total   $ 155    $ 100  $ 99 $ 421

             

NOTE 4 — INVESTMENTS

Investment Components

The components of investments were as follows:

Fair Value Unrealized Unrealized Recorded Cash and Cash Short-term Equity

(In millions) Level Cost Basis Gains Losses Basis Equivalents Investments Investments
 
 
December 31, 2019

Changes in Fair Value Recorded in

Other Comprehensive Income
 

2,22
Commercial paper Level 2 $ 3,966 $ 0 $ 0 $ 3,966 $ 1,742 $ 4 $ 0
Certificates of deposit Level 2 2,591 0 0 2,591 1,548 1,043 0
U.S. government securities Level 1 102,567 1,995 (105) 104,457 0 104,457 0
U.S. agency securities Level 2 399 0 0 399 0 399 0
Foreign government bonds Level 2 6,605 5 (10) 6,600 680 5,920 0
Mortgage- and asset-backed
securities Level 2 3,862 12 (2) 3,872 0 3,872 0
Corporate notes and bonds Level 2 6,900 130 (7) 7,023 0 7,023 0
Corporate notes and bonds Level 3 13 0 0 13 0 13 0
Municipal securities Level 2 289 49 0 338 0 338 0
Municipal securities Level 3 78 0 0 78 0 78 0
  
  
Total debt investments $ 127,270 $ 2,191 $ (124) $ 129,337 $ 3,970 $ 125,367 $ 0
  
 
Changes in Fair Value Recorded in
Net Income
 

Equity investments Level 1 $ 1,074 $ 618 $ 0 $ 456

Equity investments Other 2,299 0 0 2,299
  
Total equity investments $ 3,373 $ 618 $ 0 $ 2,755
 
 
Cash $ 4,276 $ 4,276 $ 0 $ 0
Derivatives, net (a) 22 0 22 0
  
Total $ 137,008 $ 8,864 $ 125,389 $ 2,755
 

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Cash and
Fair Value Unrealized Unrealized Recorded Cash Short-term Equity
(In millions) Level Cost Basis Gains Losses Basis Equivalents Investments Investments
 
 
June 30, 2019

Changes in Fair Value Recorded in

Other Comprehensive Income
 

Commercial paper Level 2 $ 2,211 $ 0 $ 0 $ 2,211 $ 1,773 $ 438 $ 0

Certificates of deposit Level 2 2,018 0 0 2,018 1,430 588 0 
U.S. government securities Level 1 104,925 1,854 (104) 106,675 769 105,906 0 
U.S. agency securities Level 2 988 0 0 988 698 290 0 
Foreign government bonds Level 2 6,350 4 (8) 6,346 2,506 3,840 0 
Mortgage- and asset-backed
securities Level 2 3,554 10 (3) 3,561 0 3,561 0 
Corporate notes and bonds Level 2 7,437 111 (7) 7,541 0 7,541 0 
Corporate notes and bonds Level 3 15 0 0 15 0 15 0 
Municipal securities Level 2 242 48 0 290 0 290 0 
Municipal securities Level 3 7 0 0 7 0 7 0
  
  
Total debt investments $ 127,747 $ 2,027 $ (122) $ 129,652 $ 7,176 $ 122,476 $ 0 
  
 
Changes in Fair Value Recorded in
Net Income
 

Equity investments Level 1 $ 973 $ 409 $ 0 $ 564

Equity investments Other 2,085 0 0 2,085
  
Total equity investments $ 3,058 $ 409 $ 0 $ 2,649
 
 
Cash $ 3,771 $ 3,771 $ 0 $ 0
Derivatives, net (a) (13) 0 (13) 0
  
Total $ 136,468 $ 11,356 $ 122,463 $ 2,649
 

(a) Refer to Note 5 – Derivatives for further information on the fair value of our derivative instruments.

Equity investments presented as “Other” in the tables above include investments without readily determinable fair
values measured using the equity method or measured at cost with adjustments for observable changes in price or
impairments, and investments measured at fair value using net asset value as a practical expedient which are not
categorized in the fair value hierarchy. As of December 31, 2019 and June 30, 2019, equity investments without
readily determinable fair values measured at cost with adjustments for observable changes in price or impairments
were $1.3 billion and $1.2 billion, respectively.

Unrealized Losses on Debt Investments

Debt investments with continuous unrealized losses for less than 12 months and 12 months or greater and their
related fair values were as follows:
 
Less than 12 Months 12 Months or Greater Total
Unrealized
Losses
Unrealized Unrealized Total
(In millions) Fair Value Losses Fair Value Losses Fair Value

December 31, 2019

U.S. government and agency securities   $ 7,650    $ (97)   $ 9,121    $ (8)   $ 16,771    $ (105)
Foreign government bonds     2,545      (3)     11      (7)     2,556      (10)
Mortgage- and asset-backed securities     684      (1)     408      (1)     1,092      (2)
Corporate notes and bonds     220      (3)     137      (4)     357      (7)
Municipal securities 0 0 1 0 1 0
 
 

Total   $ 11,099    $   (104)   $   9,678    $   (20)   $  20,777    $   (124)

 

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Less than 12 Months 12 Months or Greater Total

Unrealized
Losses
Unrealized Unrealized Total
(In millions) Fair Value Losses Fair Value Losses Fair Value

June 30, 2019

U.S. government and agency securities   $ 1,491    $ (1)   $ 39,158    $ (103)   $ 40,649    $ (104)
Foreign government bonds     25      0     77      (8)     102      (8)
Mortgage- and asset-backed securities     664      (1)     378      (2)     1,042      (3)
Corporate notes and bonds     498      (3)     376      (4)     874      (7)
 
 

Total   $ 2,678    $   (5)   $   39,989    $   (117)   $  42,667    $   (122)

 

Unrealized losses from fixed-income securities are primarily attributable to changes in interest rates. Management
does not believe any remaining unrealized losses represent other-than-temporary impairments based on our
evaluation of available evidence.

Debt Investment Maturities

 
Estimated
(In millions)   Cost Basis    Fair Value 
 
 
December 31, 2019                
 

Due in one year or less   $ 40,357    $ 40,381 

Due after one year through five years     48,195      49,166 
Due after five years through 10 years     37,123      38,138
Due after 10 years     1,595      1,652 
 
 

Total   $   127,270    $  129,337 

 

NOTE 5 — DERIVATIVES

We use derivative instruments to manage risks related to foreign currencies, interest rates, equity prices, and credit;
to enhance investment returns; and to facilitate portfolio diversification. Our objectives for holding derivatives include
reducing, eliminating, and efficiently managing the economic impact of these exposures as effectively as possible.
Our derivative programs include strategies that both qualify and do not qualify for hedge accounting treatment.

Foreign Currency

Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign
currency exposures daily to maximize the economic effectiveness of our foreign currency hedge positions.

Foreign currency risks related to certain non-U.S. dollar-denominated investments are hedged using foreign
exchange forward contracts that are designated as fair value hedging instruments. Foreign currency risks related to
certain Euro-denominated debt are hedged using foreign exchange forward contracts that are designated as cash
flow hedging instruments.

In the past, option and forward contracts were used to hedge a portion of forecasted international revenue and were
designated as cash flow hedging instruments. Principal currencies hedged included the Euro, Japanese yen, British
pound, Canadian dollar, and Australian dollar.

Certain options and forwards not designated as hedging instruments are also used to manage the variability in
foreign exchange rates on certain balance sheet amounts and to manage other foreign currency exposures. 

14
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Interest Rate

Interest rate risks related to certain fixed-rate debt are hedged using interest rate swaps that are designated as fair
value hedging instruments to effectively convert the fixed interest rates to floating interest rates.

Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We
manage the average maturity of our fixed-income portfolio to achieve economic returns that correlate to certain
broad-based fixed-income indices using exchange-traded option and futures contracts and over-the-counter swap
and option contracts. These contracts are not designated as hedging instruments and are included in “Other
contracts” in the tables below.

Equity

Securities held in our equity investments portfolio are subject to market price risk. Market price risk is managed
relative to broad-based global and domestic equity indices using certain convertible preferred investments, options,
futures, and swap contracts not designated as hedging instruments. These contracts are not designated as hedging
instruments and are included in “Other contracts” in the tables below.

Credit

Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We use credit default
swap contracts to manage credit exposures relative to broad-based indices and to facilitate portfolio diversification.
These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below.

Credit-Risk-Related Contingent Features

Certain of our counterparty agreements for derivative instruments contain provisions that require our issued and
outstanding long-term unsecured debt to maintain an investment grade credit rating and require us to maintain
minimum liquidity of $1.0 billion. To the extent we fail to meet these requirements, we will be required to post
collateral, similar to the standard convention related to over-the-counter derivatives. As of December 31, 2019, our
long-term unsecured debt rating was AAA, and cash investments were in excess of $1.0 billion. As a result, no
collateral was required to be posted.

The following table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar
equivalents:

December 31, June 30,

(In millions)   2019    2019 
 
 
Designated as Hedging Instruments       
       
 

Foreign exchange contracts purchased $ 438 $ 0

Foreign exchange contracts sold   6,440   6,034 
Interest rate contracts purchased 1,187 0
 
Not Designated as Hedging Instruments          
 

Foreign exchange contracts purchased 11,460 14,889

Foreign exchange contracts sold 11,738 15,614
Other contracts purchased    1,715    2,007 
Other contracts sold    463    456 
 
 

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Fair Values of Derivative Instruments

The following table presents our derivative instruments:

Derivative Derivative Derivative Derivative

(In millions) Assets Liabilities Assets Liabilities
 
 
December 31, June 30,
2019 2019
Designated as Hedging Instruments
 

Foreign exchange contracts $ 33 $ (24 ) $ 0 $ (93)

Interest rate contracts 0 (11 ) 0 0
 
Not Designated as Hedging Instruments
 

Foreign exchange contracts   165   (148 )   204    (172)

Other contracts 33 (4 ) 46 (7)
 
 

Gross amounts of derivatives 231 (187 ) 250 (272)

Gross amounts of derivatives offset in the balance sheet   (85 ) 86   (113)   114
Cash collateral received     0 (93 )      0     (78)
 
 

Net amounts of derivatives  $ 146 $ (194 )   $ 137   $ (236 )

 
  
Reported as
 

Short-term investments $ 22 $ 0 $ (13) $ 0

Other current assets 133 0 146 0
Other long-term assets (9 ) 0 4 0
Other current liabilities 0 (150 ) 0 (221)
Other long-term liabilities 0 (44 ) 0 (15)
 
 

Total  $ 146   $ (194 )   $ 137    $ (236)

                   

Gross derivative assets and liabilities subject to legally enforceable master netting agreements for which we have
elected to offset were $227 million and $187 million, respectively, as of December 31, 2019, and $247 million and
$272 million, respectively, as of June 30, 2019.  

The following table presents the fair value of our derivatives instruments on a gross basis:

(In millions) Level 1 Level 2 Level 3 Total

 
 
December 31, 2019
 

Derivative assets $ 1 $ 227 $ 3 $ 231

Derivative liabilities 0 (187) 0 (187)
 
June 30, 2019
 

Derivative assets 0 247 3 250

Derivative liabilities 0 (272) 0 (272)
 

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Gains (losses) on derivative instruments recognized in our consolidated income statements were as follows:

Three Months Ended Six Months Ended

December 31, December 31,
2019 2018 2019 2018
Other Other Other Other
Income Income Income Income
(Expense), (Expense), (Expense), (Expense),
(In millions) Revenue Net Revenue Net Revenue Net Revenue Net

Designated as Fair Value Hedging

Instruments
 

Foreign exchange contracts

Derivatives $ 0$ 23 $ 0$ (184)$ 0$ 53 $ 0$ (62)
Hedged items 0 (26) 0 184 0 (59) 0 62
Excluded from effectiveness
assessment 0 42 0 45 0 83 0 73
Interest rate contracts
Derivatives 0 (14) 0 0 0 (13) 0 0
Hedged items 0 13 0 0 0 12 0 0
 
Designated as Cash Flow Hedging
Instruments
 

Foreign exchange contracts

Amount reclassified from
accumulated other
comprehensive income 0 8 88 0 0 3 180 0
Excluded from effectiveness
assessment 0 0 0 (14) 0 0 0 (41)
 
Not Designated as Hedging Instruments
 

Foreign exchange contracts 0 52 0 (79) 0 (119) 0 (109)

Other contracts 0 1 0 8 0 2 0 5
 

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Gains (losses), net of tax, on derivative instruments recognized in our consolidated comprehensive income
statements were as follows:

Three Months Ended Six Months Ended

(In millions) December 31, December 31,
 

2019 2018 2019 2018

Designated as Cash Flow Hedging Instruments
 

Foreign exchange contracts  

Included in effectiveness assessment $ 2 $ 70 $ (4) $ 114
 

NOTE 6 — INVENTORIES

The components of inventories were as follows:

(In millions)           
 
 

December 31, June 30,

  2019     2019  
 

Raw materials   $ 409    $ 399 

Work in process     49      53 
Finished goods     1,365      1,611 
       
 

Total   $ 1,823    $ 2,063 

             

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NOTE 7 — GOODWILL

Changes in the carrying amount of goodwill were as follows:

June 30, December 31,

(In millions)   2019   Acquisitions    Other    2019 
 
 

Productivity and Business Processes   $ 24,277   $ 7  $ (18)  $ 24,266 

Intelligent Cloud     11,351     118     19   11,488 
More Personal Computing     6,398     96     0    6,494 
 
 

Total   $ 42,026   $ 221   $ 1  $ 42,248 

 

The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on
the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12
months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during
the periods in which the adjustments are determined.

Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting
adjustments are presented as “Other” in the table above. Also included in “Other” are business dispositions and
transfers between segments due to reorganizations, as applicable.

NOTE 8 — INTANGIBLE ASSETS

The components of intangible assets, all of which are finite-lived, were as follows:

Gross Net Gross Net

Carrying Accumulated Carrying Carrying Accumulated Carrying
(In millions)   Amount    Amortization    Amount    Amount   Amortization    Amount 
 
 
December 31, June 30,
2019 2019 
 

Technology-based   $ 7,821    $ (6,097)   $ 1,724    $ 7,691     $ (5,771)   $ 1,920 

Customer-related     4,673      (2,030)     2,643      4,709       (1,785)     2,924 
Marketing-related     4,157      (1,453)     2,704      4,165       (1,327)     2,838 
Contract-based     475      (420)     55      574       (506)     68 
 
 

Total   $   17,126   $   (10,000)   $ 7,126    $   17,139   $   (9,389)   $ 7,750 

 

Intangible assets amortization expense was $411 million and $845 million for the three and six months ended
December 31, 2019, respectively, and $530 million and $1.1 billion for the three and six months ended December 31,
2018, respectively.

The following table outlines the estimated future amortization expense related to intangible assets held as of
December 31, 2019:

(In millions)      
 
 
Year Ending June 30,        
 

2020 (excluding the six months ended December 31, 2019)   $ 687 
2021     1,346 
2022     1,246 
2023     1,088 
2024     757 
Thereafter     2,002 
 
 

Total   $ 7,126 
 

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NOTE 9 — DEBT

The components of debt were as follows:

Maturities Stated Interest Effective Interest December 31, June 30,

(In millions, issuance by calendar year)   (calendar year)  Rate   Rate 2019    2019 
 
 

2009 issuance of $3.8 billion   2039    5.20%   5.24% $ 750    $ 750 

2010 issuance of $4.8 billion    2020– 2040     3.00%–4.50%  3.14%–4.57%   2,000      2,000 
2011 issuance of $2.3 billion    2021– 2041     4.00%–5.30%  4.08%–5.36%   1,500      1,500 
2012 issuance of $2.3 billion 2022– 2042 2.13%–3.50% 2.24%–3.57% 1,650 1,650
2013 issuance of $5.2 billion    2023– 2043     2.38%–4.88%  2.47%–4.92%   3,500      3,500 
2013 issuance of €4.1 billion 2021– 2033 2.13%–3.13% 2.23%–3.22% 4,546 4,613
2014 issuance 0 18
2015 issuance of $23.8 billion    2020– 2055     1.85%–4.75%  1.93%–4.78%   22,000      22,000 
2016 issuance of $19.8 billion    2021– 2056     1.55%–3.95%  1.64%–4.03%   17,250      19,750 
2017 issuance of $17.0 billion    2020– 2057     1.85%–4.50%  1.95%–4.53%   17,000      17,000 
  
Total face value           70,196      72,781 
Unamortized discount and
issuance costs (577) (603)
Hedge fair value adjustments (a) (11) 0
  
Total debt       69,608      72,178 
Current portion of long-term debt (6,247) (5,516)
  
Long-term debt $ 63,361 $ 66,662
                         

(a) Refer to Note 5 – Derivatives for further information on the interest rate swaps related to fixed-rate debt.

As of December 31, 2019 and June 30, 2019, the estimated fair value of long-term debt, including the current portion,
was $78.0 billion and $78.9 billion, respectively. The estimated fair values are based on Level 2 inputs.

Debt in the table above is comprised of senior unsecured obligations and ranks equally with our other outstanding
obligations. Interest is paid semi-annually, except for the Euro-denominated debt, which is paid annually.

The following table outlines maturities of our long-term debt for each of the next five years and thereafter as of
December 31, 2019:

(In millions)

Year Ending June 30,

2020 (excluding the six months ended December 31, 2019) $ 3,000
2021 3,750
2022 7,964
2023 2,750
2024 5,250
Thereafter 47,482
Total $ 70,196

NOTE 10 — INCOME TAXES

Tax Cuts and Jobs Act

On December 22, 2017, the Tax Cuts and Jobs Act ("TCJA”) was enacted into law, which significantly changed
existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional net
charge related to the enactment of the TCJA in fiscal year 2018 and adjusted the provisional net charge by recording
additional tax expense of $157 million in the second quarter of fiscal year 2019 pursuant to SEC Staff Accounting
Bulletin No. 118.

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Effective Tax Rate

Our effective tax rate was 17% and 19% for the three months ended December 31, 2019 and 2018, respectively, and
17% and 16% for the six months ended December 31, 2019 and 2018, respectively. The decrease in our effective
tax rate for the three months ended December 31, 2019 compared to the prior year was primarily due to the
adjustment of the provisional net charge related to the TCJA in the second quarter of fiscal year 2019. The increase
in our effective tax rate for the six months ended December 31, 2019 compared to the prior year was primarily due to
changes in the mix of our income before income taxes between the U.S. and foreign countries, offset in part by the
adjustment of the provisional net charge related to the TCJA.

Our effective tax rate was lower than the U.S. federal statutory rate for the three and six months ended December 31,
2019, primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing
our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax
benefits relating to stock-based compensation.

Uncertain Tax Positions

As of December 31, 2019 and June 30, 2019, unrecognized tax benefits and other income tax liabilities were $16.0
billion and $15.3 billion, respectively, and are included in long-term income taxes in our consolidated balance sheets.

We settled a portion of the Internal Revenue Service (“IRS”) audit for tax years 2004 to 2006 in fiscal year 2011. In
February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to
2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007
to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain
under audit for tax years 2004 to 2013. We expect the IRS to begin an examination of tax years 2014 to 2017 within
the next 12 months.

As of December 31, 2019, the primary unresolved issues for the IRS audits relate to transfer pricing, which could
have a material impact in our consolidated financial statements when the matters are resolved. We believe our
allowances for income tax contingencies are adequate. We have not received a proposed assessment for the
unresolved 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 are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain
subject to examination for tax years 1996 to 2019, some of which are currently under audit by local tax authorities.
The resolution of each of these audits is not expected to be material to our consolidated financial statements.

NOTE 11 — UNEARNED REVENUE

Unearned revenue by segment was as follows:

 
(In millions)            
 
 
December 31, June 30,
  2019    2019 
 

Productivity and Business Processes   $ 14,266    $ 16,831 

Intelligent Cloud     13,766      16,988 
More Personal Computing     3,189      3,387 
 
 

Total   $ 31,221    $ 37,206 

 

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Changes in unearned revenue were as follows:

 
(In millions)      
 
 

Six Months Ended December 31, 2019

 

Balance, beginning of period  $ 37,206

Deferral of revenue    31,108
Recognition of unearned revenue    (37,093)
 
 

Balance, end of period   $ 31,221

       

Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be
invoiced and recognized as revenue in future periods, was $93 billion as of December 31, 2019, of which $90 billion
is related to the commercial portion of revenue. We expect to recognize approximately 50% of this revenue over the
next 12 months and the remainder thereafter. Many customers are committing to our products and services for
longer contract terms, which is increasing the percentage of remaining performance obligations that will be
recognized beyond the next 12 months.

NOTE 12 — LEASES

We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail
stores, and certain equipment. Our leases have remaining lease terms of 1 year to 20 years, some of which include
options to extend the leases for up to 5 years, and some of which include options to terminate the leases within 1
year.

The components of lease expense were as follows:

Three Months Ended Six Months Ended 

(In millions) December 31, December 31,
 
 
2019 2018 2019 2018
 

Operating lease cost $ 478 $ 413  $ 943 $ 823

Finance lease cost:

Amortization of right-of-use assets   $ 163   $ 84 $ 288 $ 162
Interest on lease liabilities   84   59 162 114
       
 

Total finance lease cost   $ 247   $ 143 $ 450 $ 276

            

Supplemental cash flow information related to leases was as follows:

Three Months Ended Six Months Ended

(In millions) December 31, December 31,
 
 
2019 2018 2019 2018
 

Cash paid for amounts included in the measurement of

lease liabilities:
Operating cash flows from operating leases $ 479 $ 407 $ 932 $ 804
Operating cash flows from finance leases   84   59 162 114
Financing cash flows from finance leases 104 54 183 101
Right-of-use assets obtained in exchange for lease
obligations:    
Operating leases 948 472 1,931 968
Finance leases 863 645 2,352 1,064
 

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Supplemental balance sheet information related to leases was as follows:

 
(In millions, except lease term and discount rate)            
 
 
December 31, June 30,
    2019    2019 
 

Operating Leases

Operating lease right-of-use assets $ 8,439 $ 7,379

Other current liabilities $ 1,616 $ 1,515

Operating lease liabilities 7,172 6,188
 

Total operating lease liabilities $ 8,788 $ 7,703

Finance Leases
Property and equipment, at cost $ 9,403 $ 7,041
Accumulated depreciation (1,062) (774)
 

Property and equipment, net $ 8,341 $ 6,267

Other current liabilities $ 464 $ 317

Other long-term liabilities 8,287 6,257
 

Total finance lease liabilities $ 8,751 $ 6,574

Weighted Average Remaining Lease Term
Operating leases 7 years 7 years
Finance leases 13 years 13 years
 
Weighted Average Discount Rate
 

Operating leases 2.8% 3.0%

Finance leases 4.1% 4.6%
 

Maturities of lease liabilities were as follows:

(In millions)
 
 

Operating Finance
Year Ending June 30,   Leases    Leases  
 

2020 (excluding the six months ended December 31, 2019)

 $ 966    $ 393 
2021
   1,705      804 
2022 1,507 819
2023
   1,306      827 
2024
   1,084      838 
Thereafter
 
   3,394      7,619 
 

Total lease payments 9,962    11,300 

 
Less imputed interest
 
   (1,174)     (2,549)
 

Total
 $ 8,788   $ 8,751

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 PART I
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As of December 31, 2019, we have additional operating and finance leases, primarily for datacenters, that have not
yet commenced of $2.4 billion and $4.2 billion, respectively. These operating and finance leases will commence
between fiscal year 2020 and fiscal year 2022 with lease terms of 1 year to 16 years.

NOTE 13 — CONTINGENCIES

Patent and Intellectual Property Claims

There were 50 patent infringement cases pending against Microsoft as of December 31, 2019, none of which are
material individually or in aggregate.

Antitrust, Unfair Competition, and Overcharge Class Actions

Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec,
Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft
operating system software and/or productivity application software between 1998 and 2010.

The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a
global settlement of all three Canadian actions, and submitted the proposed settlement agreement to the courts in all
three jurisdictions for approval. The final settlement has been approved by the courts in British Columbia, Ontario,
and Quebec, and the claims administration process will commence once the court approves the form of notice to the
class.

Other Antitrust Litigation and Claims

China State Administration for Industry and Commerce Investigation

In 2014, Microsoft was informed that China’s State Agency for Market Regulation (“SAMR”) (formerly State
Administration for Industry and Commerce) had begun a formal investigation relating to China’s Anti-Monopoly Law,
and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu.
The SAMR has presented its preliminary views as to certain possible violations of China's Anti-Monopoly Law, and
discussions are expected to continue.

Product-Related Litigation

U.S. Cell Phone Litigation

Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a
defendant in 40 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that
radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed
responsibility for these claims in our agreement to acquire Nokia’s Devices and Services business and have been
substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial
proceedings; the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of
Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S.
Federal Communications Commission radio frequency emission guidelines (“FCC Guidelines”) are pre-empted by
federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were
manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to
manipulate the science and testing around emission guidelines.

In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs’ expert evidence of general
causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part
the defendants’ motion to exclude the plaintiffs’ general causation experts. The defendants filed an interlocutory
appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence.
In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and
remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed
supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court
issued an order striking portions of the plaintiffs’ expert reports. A hearing is scheduled for June 2020.

24
 PART I
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Employment-Related Litigation

Moussouris v. Microsoft

Current and former female Microsoft employees in certain engineering and information technology roles brought this
class action in federal court in Seattle in 2015, alleging systemic gender discrimination in pay and promotions. The
plaintiffs moved to certify the class in October 2017. Microsoft filed an opposition in January 2018, attaching an
expert report showing no statistically significant disparity in pay and promotions between similarly situated men and
women. In June 2018, the court denied the plaintiffs’ motion for class certification. In December 2019, the U.S. Court
of Appeals for the Ninth Circuit affirmed the denial of class certification.

Other Contingencies

We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our
business. Although management currently believes that resolving claims against us, individually or in aggregate, will
not have a material adverse impact in our consolidated financial statements, these matters are subject to inherent
uncertainties and management’s view of these matters may change in the future.

As of December 31, 2019, we accrued aggregate legal liabilities of $319 million. While we intend to defend these
matters vigorously, adverse outcomes that we estimate could reach approximately $900 million in aggregate beyond
recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a
material adverse impact in our consolidated financial statements for the period in which the effects become
reasonably estimable.

NOTE 14 — STOCKHOLDERS’ EQUITY

Share Repurchases

On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion
in share repurchases. This share repurchase program commenced on December 22, 2016, has no expiration date,
and may be suspended or discontinued at any time without notice. As of December 31, 2019, $2.8 billion remained of
this $40.0 billion share repurchase program.

On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion
in share repurchases. This share repurchase program will commence following completion of the program approved
on September 20, 2016, has no expiration date, and may be terminated at any time.

We repurchased the following shares of common stock under the share repurchase program:

(In millions)   Shares Amount   Shares Amount 

 
 
Fiscal Year       2020        2019 
 

First Quarter     29   $ 4,000      24    $ 2,600 

Second Quarter 32 4,600 57 6,100

Total 61 $ 8,600 81 $ 8,700

The shares repurchased were under the share repurchase program approved on September 20, 2016. The above
table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $551
million and $1.5 billion for the three and six months ended December 31, 2019, respectively, and $313 million and
$1.5 billion for the three and six months ended December 31, 2018, respectively. All repurchases were made using
cash resources.

25
 PART I
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Dividends

Our Board of Directors declared the following dividends:

Dividend
Declaration Date Record Date Payment Date Per Share Amount

Fiscal Year 2020 (In millions)

September 18, 2019   November 21, 2019       December 12, 2019    $ 0.51    $ 3,886 
December 4, 2019 February 20, 2020 March 12, 2020 0.51 3,881
 
 

Total $ 1.02 $ 7,767

 
 
Fiscal Year 2019
 

September 18, 2018   November 15, 2018       December 13, 2018    $ 0.46    $ 3,544 

November 28, 2018 February 21, 2019 March 14, 2019 0.46 3,526
 
 

Total $ 0.92 $ 7,070

 

The dividend declared on December 4, 2019 was included in other current liabilities as of December 31, 2019.

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NOTE 15 — ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes the changes in accumulated other comprehensive income (loss) by component:

Three Months Ended Six Months Ended
(In millions) December 31, December 31,

2019 2018 2019 2018

Derivatives              
 

Balance, beginning of period  $ (2)   $ 128  $ 0 $ 173

Unrealized gains (losses), net of tax of $1, $3, $(1), and $2   2      71  (4) 115
 

Reclassification adjustments for gains included in earnings    (8)     (88)    (3)   (180)
Tax expense included in provision for income taxes    2      2  1 5
 
 

Amounts reclassified from accumulated other   

comprehensive income (loss)    (6)     (86) (2) (175)
 
 

Net change related to derivatives, net of tax of $(1), $1, $(2),

and $(3)    (4)     (15) (6) (60)
 
 

Balance, end of period  $ (6)   $ 113 $ (6) $ 113

 
 
Investments             
 

Balance, beginning of period  $ 2,065    $ (1,178)  $ 1,488 $ (850)

Unrealized gains (losses), net of tax of $(111), $234, $45,
and $148 (414) 879 162 556
 

Reclassification adjustments for (gains) losses included in   

other income (expense), net    (7)     2 (6) 80
Tax expense (benefit) included in provision for income taxes     1      0  1 (16)
 
 

Amounts reclassified from accumulated other

comprehensive income (loss)    (6)     2 (5) 64
 
 

Net change related to investments, net of tax of $(112),       

$234, $44, and $164    (420)    881 157 620
Cumulative effect of accounting changes 0 0 0 (67)
 
 

Balance, end of period  $ 1,645    $ (297)  $   1,645 $ (297)

 
                
Translation Adjustments and Other
 

Balance, beginning of period  $ (2,124)   $ (1,565) $ (1,828) $ (1,510)

Translation adjustments and other, net of tax of $0, $(1),
$(8), and $(1)    230     (264) (66) (319)
 
 

Balance, end of period  $ (1,894)   $ (1,829) $  (1,894) $ (1,829)

 
 

Accumulated other comprehensive loss, end of period  $ (255)   $ (2,013) $ (255) $ (2,013)
 

NOTE 16 — SEGMENT INFORMATION AND GEOGRAPHIC DATA

In its operation of the business, management, including our chief operating decision maker, who is also our Chief
Executive Officer, reviews certain financial information, including segmented internal profit and loss statements
prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance
based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal
Computing.

Our reportable segments are described below.

27
 PART I
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Productivity and Business Processes

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, including Microsoft Office 365 subscriptions and Office licensed on-premises,
comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and
Skype for Business, and related Client Access Licenses (“CALs”).
• Office Consumer, including Office 365 subscriptions and Office licensed on-premises, and Office
Consumer Services, including Skype, Outlook.com, and OneDrive.
• LinkedIn, including Talent Solutions, Marketing Solutions, and Premium Subscriptions.
• Dynamics business solutions, including Microsoft Dynamics 365, a set of cloud-based applications across
ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises.

Intelligent Cloud

Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can
power modern business and developers. This segment primarily comprises:
• Server products and cloud services, including Microsoft Azure; Microsoft SQL Server, Windows Server,
Visual Studio, System Center, and related CALs; and GitHub.
• Enterprise Services, including Premier Support Services and Microsoft Consulting Services.

More Personal Computing

Our More Personal Computing segment consists of products and services that put customers at the center of the
experience with our technology. This segment primarily comprises:
• Windows, including Windows original equipment manufacturer (“OEM”) licensing and other non-volume
licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the
Windows operating system, Windows cloud services, and other Windows commercial offerings; patent
licensing; Windows Internet of Things (“IoT”); and MSN advertising.
• Devices, including Microsoft Surface and PC accessories.
• Gaming, including Xbox hardware and Xbox content and services, comprising Xbox Live transactions,
subscriptions, cloud services, and advertising (“Xbox Live”), video games, and third-party video game
royalties.
• Search.

Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our
business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue
from certain contracts is allocated among the segments based on the relative value of the underlying products and
services, which can include allocation based on actual prices charged, prices when sold separately, or estimated
costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology.
Operating expenses that are allocated primarily include those relating to marketing of products and services from
which multiple segments benefit and are generally allocated based on relative gross margin.

In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated
to them. These allocated costs include costs of: legal, including settlements and fines; information technology;
human resources; finance; excise taxes; field selling; shared facilities services; and customer service and support.
Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated.
Certain corporate-level activity is not allocated to our segments.

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Segment revenue and operating income were as follows during the periods presented:

Three Months Ended Six Months Ended
(In millions)   December 31,    December 31, 

    2019    2018    2019    2018 

  
Revenue              
 

Productivity and Business Processes   $ 11,826    $ 10,100    $ 22,903    $ 19,871 

Intelligent Cloud     11,869      9,378      22,714      17,945 
More Personal Computing     13,211      12,993      24,344      23,739 
               
 

Total   $ 36,906    $ 32,471    $ 69,961    $ 61,555 

                         
 

Operating Income                
 

Productivity and Business Processes   $ 5,182    $ 4,015    $ 9,964    $ 7,896 

Intelligent Cloud     4,531      3,279      8,420      6,210 
More Personal Computing     4,178      2,964      8,193      6,107 

Total   $ 13,891    $ 10,258    $ 26,577   $ 20,213 

                         

No sales to an individual customer or country other than the United States accounted for more than 10% of revenue
for the three or six months ended December 31, 2019 or 2018. Revenue, classified by the major geographic areas in
which our customers were located, was as follows:

Three Months Ended Six Months Ended
(In millions)   December 31,    December 31, 
  
 

    2019    2018    2019    2018 

 

United States (a)   $ 19,149   $ 16,787   $ 36,419   $ 31,527

Other countries     17,757      15,684      33,542      30,028 
                   

Total   $ 36,906    $ 32,471    $ 69,961    $ 61,555 

                         

(a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses
and the impracticability of determining the geographic source of the revenue.
Revenue from external customers, classified by significant product and service offerings, was as follows:

Three Months Ended Six Months Ended
(In millions)   December 31,    December 31, 
  
 

    2019    2018    2019    2018 

 

Server products and cloud services   $ 10,119    $ 7,791    $ 19,311    $ 14,849 

Office products and cloud services     8,983     7,747     17,449     15,369
Windows     5,593      4,758      10,946      9,659 
Gaming     3,327     4,232     5,869     6,970
Search advertising 2,163 1,976 4,154 3,764
LinkedIn 2,102 1,693 4,011 3,223
Devices     2,048     1,948     3,250     3,209
Enterprise Services 1,612 1,521 3,157 2,971
Other     959     805     1,814     1,541
             

Total   $ 36,906   $ 32,471   $ 69,961   $ 61,555

                         

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Our commercial cloud revenue, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn,
Dynamics 365, and other commercial cloud properties, was $12.5 billion and $24.1 billion for the three and six
months ended December 31, 2019, respectively, and $9.0 billion and $17.5 billion for the three and six months ended
December 31, 2018, respectively. These amounts are primarily included in Office products and cloud services,
Server products and cloud services, and LinkedIn in the table above.

Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation
is included with various other costs in an overhead allocation to each segment. It is impracticable for us to separately
identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or
loss.

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 PART I
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Microsoft Corporation

Results of Review of Interim Financial Information

We have reviewed the accompanying consolidated balance sheet of Microsoft Corporation and subsidiaries (the
"Company") as of December 31, 2019, the related consolidated statements of income, comprehensive income, cash
flows, and stockholders’ equity for the three-month and six-month periods ended December 31, 2019 and 2018, and
the related notes (collectively referred to as the “interim financial information”). Based on our reviews, we are not
aware of any material modifications that should be made to the accompanying interim financial information for it to be
in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States) (“PCAOB”), the consolidated balance sheet of the Company as of June 30, 2019, and the related
consolidated statements of income, comprehensive income, cash flows, and stockholders’ equity for the year then
ended (not presented herein); and in our report dated August 1, 2019, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance
sheet as of June 30, 2019, is fairly stated, in all material respects, in relation to the consolidated balance sheet from
which it has been derived.

Basis for Review Results

This interim financial information is the responsibility of the Company's management. We are a public accounting firm
registered with the PCAOB and are required to be independent with respect to the Company in accordance with the
U.S. federal securities laws and the applicable rules and regulations of the PCAOB and the Securities and Exchange
Commission.

We conducted our reviews in accordance with standards of the PCAOB. A review of interim financial information
consists principally of applying analytical procedures and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the
PCAOB, the objective of which is the expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.

/S/ DELOITTE & TOUCHE LLP

Seattle, Washington
January 29, 2020

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 PART I
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Note About Forward-Looking Statements

This report includes estimates, projections, statements relating to our business plans, objectives, and expected
operating results that are “forward-looking statements” within the meaning of the Private Securities Litigation Reform
Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934.
Forward-looking statements may appear throughout this report, including the following sections: “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” (Part II, Item 1A of this
Form 10-Q). These forward-looking statements generally are identified by the words “believe,” “project,” “expect,”
“anticipate,” “estimate,” “intend,” “strategy,” “future,” “opportunity,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will
continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations
and assumptions that are subject to risks and uncertainties that may cause actual results to differ materially. We
describe risks and uncertainties that could cause actual results and events to differ materially in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures
about Market Risk” (Part I, Item 3 of this Form 10-Q), and “Risk Factors”. We undertake no obligation to update or
revise publicly any forward-looking statements, whether because of new information, future events, or otherwise.

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is
intended to help the reader understand the results of operations and financial condition of Microsoft Corporation.
MD&A is provided as a supplement to, and should be read in conjunction with, our Annual Report on Form 10-K for
the year ended June 30, 2019, and our financial statements and the accompanying Notes to Financial Statements
(Part I, Item 1 of this Form 10-Q).

OVERVIEW

Microsoft is a technology company whose mission is to empower every person and every organization on the planet
to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our
platforms and tools help drive small business productivity, large business competitiveness, and public-sector
efficiency. They also support new startups, improve educational and health outcomes, and empower human
ingenuity.

We generate revenue by offering a wide range of cloud-based and other services to people and businesses;
licensing and supporting an array of software products; designing, manufacturing, and selling devices; and delivering
relevant online advertising to a global audience. Our most significant expenses are related to compensating
employees; designing, manufacturing, marketing, and selling our products and services; datacenter costs in support
of our cloud-based services; and income taxes.

Highlights from the second quarter of fiscal year 2020 compared with the second quarter of fiscal year 2019 included:
• Commercial cloud revenue, which includes Microsoft Office 365 Commercial, Microsoft Azure, the
commercial portion of LinkedIn, Microsoft Dynamics 365, and other commercial cloud properties,
increased 39% to $12.5 billion.
• Office Commercial revenue increased 16%, driven by Office 365 Commercial growth of 27%.
• Office Consumer revenue increased 19%, and Office 365 Consumer subscribers increased to 37.2
million.
• LinkedIn revenue increased 24%.
• Dynamics revenue increased 12%, driven by Dynamics 365 growth of 42%.
• Server products and cloud services revenue increased 30%, driven by Azure growth of 62%.
• Enterprise Services revenue increased 6%.
• Windows original equipment manufacturer licensing (“Windows OEM”) revenue increased 18%.
• Windows Commercial revenue increased 25%.

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• Search advertising revenue, excluding traffic acquisition costs, increased 6%.

• Microsoft Surface revenue increased 6%.
• Xbox content and services revenue decreased 11%.

Industry Trends

Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models.
Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further
transform the industry and our business. At Microsoft, we push the boundaries of what is possible through a broad
range of research and development activities that seek to identify and address the changing demands of customers
and users, industry trends, and competitive forces.

Economic Conditions, Challenges, and Risks

The markets for software, devices, and cloud-based services are dynamic and highly competitive. Our competitors
are developing new software and devices, while also deploying competing cloud-based services for consumers and
businesses. The devices and form factors customers prefer evolve rapidly, and influence how users access services
in the cloud, and in some cases, the user’s choice of which suite of cloud-based services to use. We must continue to
evolve and adapt over an extended time in pace with this changing environment. The investments we are making in
infrastructure and devices will continue to increase our operating costs and may decrease our operating margins.

Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university
and industry talent worldwide. We compete for talented individuals globally by offering an exceptional working
environment, broad customer reach, scale in resources, the ability to grow one’s career across many different
products and businesses, and competitive compensation and benefits. Aggregate demand for our software, services,
and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.

Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue
and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in foreign exchange
rates may significantly affect revenue and expenses. Strengthening of the U.S. dollar relative to certain foreign
currencies reduced reported revenue and expenses from our international operations in the first and second quarter
of fiscal year 2020.

Refer to Risk Factors (Part II, Item 1A of this Form 10-Q) for a discussion of these factors and other risks.

Seasonality

Our revenue fluctuates quarterly and is generally higher in the second and fourth quarters of our fiscal year. Second
quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending
by consumers, and fourth quarter revenue is driven by the volume of multi-year on-premises contracts executed
during the period.

Reportable Segments

We report our financial performance based on the following segments: Productivity and Business Processes,
Intelligent Cloud, and More Personal Computing. The segment amounts included in MD&A are presented on a basis
consistent with our internal management reporting. All differences between our internal management reporting basis
and accounting principles generally accepted in the United States of America (“GAAP”), along with certain corporate-
level and other activity, are included in Corporate and Other.

Additional information on our reportable segments is contained in Note 16 – Segment Information and Geographic
Data of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q).

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Item 2

SUMMARY RESULTS OF OPERATIONS

(In millions, except percentages and per share Three Months Ended Percentage Six Months Ended Percentage

amounts) December 31, Change December 31, Change

2019 2018 2019 2018

Revenue  $ 36,906   $ 32,471     14%   $ 69,961 $ 61,555 14%

Gross margin   24,548   20,048     22%   47,197 39,227 20%
Operating income   13,891   10,258     35%   26,577 20,213 31%
Net income 11,649 8,420 38% 22,327 17,244 29%
Diluted earnings per share 1.51 1.08 40% 2.90 2.22 31%

Non-GAAP net income 11,649 8,577 36% 22,327 17,401 28%

Non-GAAP diluted earnings per share 1.51 1.10 37% 2.90 2.24 29%

Non-GAAP net income and diluted earnings per share (“EPS”) exclude the net charge related to the Tax Cuts and
Jobs Act (“TCJA”) of $157 million in the second quarter of fiscal year 2019. Refer to the Non-GAAP Financial
Measures section below for a reconciliation of our financial results reported in accordance with GAAP to non-GAAP
financial results.

The financial results of GitHub have been included in our consolidated financial statements since the date of the
acquisition on October 25, 2018.

Three Months Ended December 31, 2019 Compared with Three Months Ended December 31, 2018

Revenue increased $4.4 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue
increased, driven by server products and cloud services. Productivity and Business Processes revenue increased,
driven by Office and LinkedIn. More Personal Computing revenue increased, driven by Windows, offset in part by a
decrease in Gaming.

Gross margin increased $4.5 billion or 22%, driven by growth across each of our segments. Gross margin
percentage increased, driven by sales mix shift to higher margin businesses. Gross margin included a 5-point
improvement in commercial cloud, primarily from Azure.

Operating income increased $3.6 billion or 35%, driven by growth across each of our segments.

Key changes in expenses were:

• Cost of revenue decreased $65 million or 1%, driven by a decline in Gaming, offset in part by growth in
commercial cloud.
• Research and development expenses increased $533 million or 13%, driven by investments in cloud
engineering, LinkedIn, and Gaming.
• Sales and marketing expenses increased $345 million or 8%, driven by investments in LinkedIn and
commercial sales.
• General and administrative expenses decreased $11 million or 1%.

Gross margin and operating income included an unfavorable foreign currency impact of 3% and 4%, respectively.

Prior year net income and diluted EPS were negatively impacted by the net charge related to the TCJA, which
resulted in a decrease to net income and diluted EPS of $157 million and $0.02, respectively.

Six Months Ended December 31, 2019 Compared with Six Months Ended December 31, 2018

Revenue increased $8.4 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue
increased, driven by server products and cloud services. Productivity and Business Processes revenue increased,
driven by Office and LinkedIn. More Personal Computing revenue increased, driven by Windows, offset in part by a
decrease in Gaming.

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 PART I
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Gross margin increased $8.0 billion or 20%, driven by growth across each of our segments. Gross margin
percentage increased, driven by sales mix shift to higher margin businesses. Gross margin included a 5-point
improvement in commercial cloud, primarily from Azure.

Operating income increased $6.4 billion or 31%, driven by growth across each of our segments.

Key changes in expenses were:

• Cost of revenue increased $436 million or 2%, driven by growth in commercial cloud, offset in part by a
decline in Gaming.
• Research and development expenses increased $1.1 billion or 14%, driven by investments in cloud
engineering, LinkedIn, Gaming, and GitHub.
• Sales and marketing expenses increased $584 million or 7%, driven by investments in LinkedIn and
commercial sales.
• General and administrative expenses decreased $99 million or 4%.

Gross margin and operating income included an unfavorable foreign currency impact of 3% and 5%, respectively.

Prior year net income and diluted EPS were negatively impacted by the net charge related to the TCJA, which
resulted in a decrease to net income and diluted EPS of $157 million and $0.02, respectively.

SEGMENT RESULTS OF OPERATIONS

Three Months Ended Percentage Six Months Ended Percentage

(In millions, except percentages)   December 31,    Change  December 31, Change
 
 
    2019    2018        2019 2018
 
Revenue                        
 

Productivity and Business Processes   $ 11,826    $ 10,100      17%  $ 22,903 $ 19,871

  15%
Intelligent Cloud     11,869      9,378      27%  22,714
  17,945 27%
More Personal Computing     13,211      12,993      2%  24,344
  23,739 3%
             
 

Total   $ 36,906    $ 32,471      14%  $ 69,961 $ 61,555 14%

               
   
Operating Income                  
 

Productivity and Business Processes   $ 5,182    $ 4,015      29%  $ 9,964 $ 7,896 26%
Intelligent Cloud     4,531      3,279      38%    8,420 6,210 36%
More Personal Computing     4,178      2,964      41%  8,193 6,107 34%
 
             

Total   $ 13,891    $ 10,258      35%  $ 26,577 $ 20,213

  31%
                   

Reportable Segments

Three Months Ended December 31, 2019 Compared with Three Months Ended December 31, 2018

Productivity and Business Processes

Revenue increased $1.7 billion or 17%.

• Office Commercial revenue increased $1.1 billion or 16%, driven by Office 365 Commercial growth of
27%, due to growth in seats and revenue per user.
• Office Consumer revenue increased $190 million or 19%, driven by Office 365 recurring subscription
revenue and transactional strength in Japan, as well as a benefit from a low prior year comparable.
• LinkedIn revenue increased $409 million or 24%, driven by continued strength across all businesses.
• Dynamics revenue increased 12%, driven by Dynamics 365 growth of 42%.

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 PART I
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Operating income increased $1.2 billion or 29%.

• Gross margin increased $1.6 billion or 21%, driven by growth in Office 365 Commercial and LinkedIn.
Gross margin percentage increased, due to gross margin percentage improvement in Office 365
Commercial and LinkedIn, offset in part by an increased mix of cloud offerings.
• Operating expenses increased $442 million or 12%, driven by investments in LinkedIn and cloud
engineering.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 2%, 2%, and 4%,
respectively.

Intelligent Cloud

Revenue increased $2.5 billion or 27%.

• Server products and cloud services revenue increased $2.3 billion or 30%, driven by Azure. Azure
revenue grew 62%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-
based services and per user-based services. Server products revenue increased 10%, due to hybrid and
premium solutions, as well as demand related to Windows Server 2008 end of support.
• Enterprise Services revenue increased $91 million or 6%, driven by growth in Premier Support Services.

Operating income increased $1.3 billion or 38%.

• Gross margin increased $1.8 billion or 28%, driven by growth in server products and cloud services
revenue and cloud services scale and efficiencies. Gross margin percentage increased, due to gross
margin percentage improvement in Azure, offset in part by an increased mix of cloud offerings.
• Operating expenses increased $575 million or 18%, driven by investments in Azure.

Gross margin and operating income included an unfavorable foreign currency impact of 3% and 4%, respectively.

More Personal Computing

Revenue increased $218 million or 2%.

• Windows revenue increased $835 million or 18%, driven by growth in Windows OEM and Windows
Commercial. Windows OEM revenue increased 18%, ahead of PC market growth that was impacted in
the prior year by chip supply constraints. Windows OEM Pro revenue grew 26%, driven by continued
momentum in advance of Windows 7 end of support and healthy Windows 10 demand, in addition to the
benefit from the low prior year comparable. Windows OEM non-Pro revenue grew 4%, driven by the
benefit from the low prior year comparable and the timing of license purchases, offset in part by continued
pressure in the entry-level category. Windows Commercial revenue increased 25%, primarily driven by an
increase in Microsoft 365 agreements, which carry higher in-quarter revenue recognition.
• Search advertising revenue increased $187 million or 9%. Search advertising revenue, excluding traffic
acquisition costs, increased 6%, driven by higher revenue per search.
• Surface revenue increased $116 million or 6%, driven by commercial growth.
• Gaming revenue decreased $905 million or 21%. Xbox hardware revenue decreased 43%, primarily due
to a decrease in volume and price of consoles sold. Xbox content and services revenue decreased $295
million or 11%, against a high prior year comparable primarily from a third-party title, offset in part by
growth in subscriptions.
Operating income increased $1.2 billion or 41%.
• Gross margin increased $1.1 billion or 18%, driven by growth in Windows and Surface. Gross margin
percentage increased, due to sales mix shift to higher margin businesses.
• Operating expenses decreased $150 million or 5%, driven by the redeployment of engineering resources,
offset in part by investments in Gaming, primarily in first-party content.

Gross margin and operating income included an unfavorable foreign currency impact of 2% and 4%, respectively.

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Six Months Ended December 31, 2019 Compared with Six Months Ended December 31, 2018

Productivity and Business Processes

Revenue increased $3.0 billion or 15%.

• Office Commercial revenue increased $1.9 billion or 14%, driven by Office 365 Commercial growth of
26%, due to growth in seats and revenue per user.
• Office Consumer revenue increased $241 million or 12%, driven by Office 365 recurring subscription
revenue and transactional strength in Japan.
• LinkedIn revenue increased $788 million or 24%, driven by continued strength across all businesses.
• Dynamics revenue increased 13%, driven by Dynamics 365 growth of 41%.

Operating income increased $2.1 billion or 26%.

• Gross margin increased $2.8 billion or 19%, driven by growth in Office 365 Commercial and LinkedIn.
Gross margin percentage increased, due to gross margin percentage improvement in LinkedIn and Office
365 Commercial, offset in part by an increased mix of cloud offerings.
• Operating expenses increased $729 million or 10%, driven by investments in LinkedIn and cloud
engineering.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 2%, 2%, and 4%,
respectively.

Intelligent Cloud

Revenue increased $4.8 billion or 27%.

• Server products and cloud services revenue increased $4.5 billion or 30%, driven by Azure. Azure
revenue grew 61%, due to higher infrastructure-as-a-service and platform-as-a-service consumption-
based services and per user-based services. Server products revenue increased 11%, due to hybrid and
premium solutions, demand related to Microsoft SQL Server 2008 and Windows Server 2008 end-of-
support, and GitHub.
• Enterprise Services revenue increased $186 million or 6%, driven by growth in Premier Support Services.

Operating income increased $2.2 billion or 36%.

• Gross margin increased $3.4 billion or 28%, driven by growth in server products and cloud services
revenue and cloud services scale and efficiencies. Gross margin percentage increased slightly, due to
gross margin percentage improvement in Azure, offset in part by an increased mix of cloud offerings.
• Operating expenses increased $1.2 billion or 20%, driven by investments in Azure, as well as GitHub.

Revenue, gross margin, and operating income included an unfavorable foreign currency impact of 2%, 2%, and 4%,
respectively.

More Personal Computing

Revenue increased $605 million or 3%.

• Windows revenue increased $1.3 billion or 13%, driven by growth in Windows OEM and Windows
Commercial. Windows OEM revenue increased 13%, ahead of PC market growth that was impacted in
the prior year by chip supply constraints. Windows OEM Pro revenue grew 22%, driven by continued
momentum in advance of Windows 7 end of support and healthy Windows 10 demand, in addition to the
benefit from the low prior year comparable. Windows OEM non-Pro revenue declined 1%, driven by
continued pressure in the entry-level category, offset in part by the benefit from the low prior year
comparable. Windows Commercial revenue increased 26%, driven by an increase in Microsoft 365
agreements, which carry higher in-quarter revenue recognition.
• Search advertising revenue increased $390 million or 10%. Search advertising revenue, excluding traffic
acquisition costs, increased 8%, driven by higher revenue per search.

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• Surface revenue increased $72 million or 2%, driven by commercial growth, offset in part by a decline in
consumer.
• Gaming revenue decreased $1.1 billion or 16%, driven by a decrease in Xbox hardware of 40%,
primarily due to a decrease in volume and price of consoles sold. Xbox content and services revenue
decreased $302 million or 6%, against a high prior year comparable primarily from a third-party title, offset
in part by growth in subscriptions.

Operating income increased $2.1 billion or 34%.

• Gross margin increased $1.8 billion or 15%, driven by growth in Windows. Gross margin percentage
increased, due to sales mix shift to higher margin businesses.
• Operating expenses decreased $334 million or 6%, driven by the redeployment of engineering resources.

Gross margin and operating income included an unfavorable foreign currency impact of 2% and 3%, respectively.

OPERATING EXPENSES

Research and Development

Three Months Ended Percentage Six Months Ended Percentage

(In millions, except percentages)   December 31,    Change  December 31, Change
 
 
    2019    2018        2019 2018
 

Research and development   $ 4,603    $ 4,070      13%  $ 9,168 $ 8,047 14%

As a percent of revenue     12%      13%      (1)ppt  13% 13% 0ppt

Research and development expenses include payroll, employee benefits, stock-based compensation expense, and
other headcount-related expenses associated with product development. Research and development expenses also
include third-party development and programming costs, localization costs incurred to translate software for
international markets, and the amortization of purchased software code and services content.

Three Months Ended December 31, 2019 Compared with Three Months Ended December 31, 2018

Research and development expenses increased $533 million or 13%, driven by investments in cloud engineering,
LinkedIn, and Gaming.

Six Months Ended December 31, 2019 Compared with Six Months Ended December 31, 2018

Research and development expenses increased $1.1 billion or 14%, driven by investments in cloud engineering,
LinkedIn, Gaming, and GitHub.

Sales and Marketing

Three Months Ended Percentage Six Months Ended Percentage

(In millions, except percentages)   December 31,    Change  December 31, Change
 
 

    2019    2018        2019 2018

 

Sales and marketing  $ 4,933    $ 4,588      8%  $ 9,270 $ 8,686 7%

As a percent of revenue    13%      14%      (1)ppt  13% 14% (1)ppt

Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other
headcount-related expenses associated with sales and marketing personnel, and the costs of advertising,
promotions, trade shows, seminars, and other programs.

Three Months Ended December 31, 2019 Compared with Three Months Ended December 31, 2018

Sales and marketing expenses increased $345 million or 8%, driven by investments in LinkedIn and commercial
sales.

Six Months Ended December 31, 2019 Compared with Six Months Ended December 31, 2018

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Sales and marketing expenses increased $584 million or 7%, driven by investments in LinkedIn and commercial
sales.

General and Administrative

Three Months Ended Percentage Six Months Ended Percentage

(In millions, except percentages)   December 31,    Change  December 31, Change
 
 

    2019    2018        2019 2018

 

General and administrative  $ 1,121    $ 1,132      (1)%  $ 2,182 $ 2,281 (4)%

As a percent of revenue    3%      3%      0ppt  3% 4% (1)ppt

General and administrative expenses include payroll, employee benefits, stock-based compensation expense,
severance expense, and other headcount-related expenses associated with finance, legal, facilities, certain human
resources and other administrative personnel, certain taxes, and legal and other administrative fees.

Three Months Ended December 31, 2019 Compared with Three Months Ended December 31, 2018

General and administrative expenses decreased $11 million or 1%.

Six Months Ended December 31, 2019 Compared with Six Months Ended December 31, 2018

General and administrative expenses decreased $99 million or 4%.

OTHER INCOME (EXPENSE), NET

The components of other income (expense), net were as follows:

Three Months Ended Six Months Ended
(In millions)   December 31, December 31,
 
 

  2019    2018  2019 2018

 

Interest and dividends income   $ 688    $ 704  $ 1,412 $ 1,385

Interest expense     (654)     (672)   (1,291)   (1,346)
Net recognized gains on investments     162     94 105 337
Net gains on derivatives     41     41 87 38
Net losses on foreign currency remeasurements     (24)     (74) (82) (69)
Other, net     (19)     34 (37) 48
 
 

Total   $ 194   $ 127 $ 194 $ 393

 

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

Three Months Ended December 31, 2019 Compared with Three Months Ended December 31, 2018

Interest and dividends income decreased due to lower yields on fixed-income securities. Interest expense decreased
due to capitalization of interest expense and a decrease in outstanding long-term debt due to debt maturities, offset
in part by higher finance lease expense. Net recognized gains on investments increased due to higher gains on
equity investments.

Six Months Ended December 31, 2019 Compared with Six Months Ended December 31, 2018

Interest and dividends income increased due to higher average portfolio balances on fixed-income securities. Interest
expense decreased due to capitalization of interest expense and a decrease in outstanding long-term debt due to
debt maturities, offset in part by higher finance lease expense. Net recognized gains on investments decreased due
to lower gains on equity investments. Net gains on derivatives increased due to higher gains on foreign exchange
derivatives.

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INCOME TAXES

Effective Tax Rate

Our effective tax rate was 17% and 19% for the three months ended December 31, 2019 and 2018, respectively, and
17% and 16% for the six months ended December 31, 2019 and 2018, respectively. The decrease in our effective
tax rate for the three months ended December 31, 2019 compared to the prior year was primarily due to the
adjustment of the provisional net charge related to the TCJA in the second quarter of fiscal year 2019. The increase
in our effective tax rate for the six months ended December 31, 2019 compared to the prior year was primarily due to
changes in the mix of our income before income taxes between the U.S. and foreign countries, offset in part by the
adjustment of the provisional net charge related to the TCJA.

Our effective tax rate was lower than the U.S. federal statutory rate for the three and six months ended December 31,
2019, primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing
our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax
benefits relating to stock-based compensation.

Uncertain Tax Positions

We settled a portion of the Internal Revenue Service (“IRS”) audit for tax years 2004 to 2006 in fiscal year 2011. In
February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to
2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007
to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain
under audit for tax years 2004 to 2013. We expect the IRS to begin an examination of tax years 2014 to 2017 within
the next 12 months.

As of December 31, 2019, the primary unresolved issues for the IRS audits relate to transfer pricing, which could
have a material impact in our consolidated financial statements when the matters are resolved. We believe our
allowances for income tax contingencies are adequate. We have not received a proposed assessment for the
unresolved 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 are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain
subject to examination for tax years 1996 to 2019, some of which are currently under audit by local tax authorities.
The resolution of each of these audits is not expected to be material to our consolidated financial statements.

NON-GAAP FINANCIAL MEASURES

Non-GAAP net income and diluted earnings per share are non-GAAP financial measures which exclude a net charge
related to the TCJA. We believe these non-GAAP measures aid investors by providing additional insight into our
operational performance and help clarify trends affecting our business. For comparability of reporting, management
considers non-GAAP measures in conjunction with GAAP financial results in evaluating business performance.
These non-GAAP financial measures presented should not be considered a substitute for, or superior to, the
measures of financial performance prepared in accordance with GAAP.

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The following table reconciles our financial results reported in accordance with GAAP to non-GAAP financial results:

Three Months Ended Percentage Six Months Ended Percentage

(In millions, except percentages and per share amounts) December 31, Change December 31, Change

2019 2018 2019 2018

Net income $ 11,649 $ 8,420 38% $ 22,327 $ 17,244 29%

Net charge related to the TCJA 0 157 * 0 157 *

Non-GAAP net income $ 11,649 $ 8,577 36% $ 22,327 $ 17,401 28%

Diluted earnings per share $ 1.51 $ 1.08 40%   $ 2.90 $ 2.22 31%
Net charge related to the TCJA 0 0.02 * 0 0.02 *

Non-GAAP diluted earnings per share $ 1.51 $ 1.10 37% $ 2.90 $ 2.24 29%

* Not meaningful.

FINANCIAL CONDITION

Cash, Cash Equivalents, and Investments

Cash, cash equivalents, and short-term investments totaled $134.3 billion and $133.8 billion as of December 31,
2019 and June 30, 2019. Equity investments were $2.8 billion and $2.6 billion as of December 31, 2019 and June 30,
2019, respectively. Our short-term investments are primarily intended to facilitate liquidity and capital preservation.
They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries
and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include
foreign currency-denominated securities to diversify risk. Our fixed-income investments are exposed to interest rate
risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve
economic returns that correlate to certain fixed-income indices. The settlement risk related to these investments is
insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income
securities.

Valuation

In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to
determine the fair value of our financial instruments. This pricing methodology applies to our Level 1 investments,
such as U.S. government securities, common and preferred stock, and mutual funds. If quoted prices in active
markets for identical assets or liabilities are not available to determine fair value, then we use quoted prices for
similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This
pricing methodology applies to our Level 2 investments, such as commercial paper, certificates of deposit, U.S.
agency securities, foreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds,
and municipal securities. Level 3 investments are valued using internally-developed models with unobservable
inputs. Assets and liabilities measured at fair value on a recurring basis using unobservable inputs are an immaterial
portion of our portfolio.

A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as
these vendors either provide a quoted market price in an active market or use observable inputs for their pricing
without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the
investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market
in which the investment trades. Our broker-priced investments are generally classified as Level 2 investments
because the broker prices these investments based on similar assets without applying significant adjustments. In
addition, all our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values
used are appropriate for these investments. Our fair value processes include controls that are designed to ensure
appropriate fair values are recorded. These controls include model validation, review of key model inputs, analysis of
period-over-period fluctuations, and independent recalculation of prices where appropriate.

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Cash Flows

Cash from operations increased $1.9 billion to $24.5 billion for the six months ended December 31, 2019, mainly due
to an increase in cash from customers, offset in part by an increase in cash used to pay suppliers, income taxes, and
employees. Cash used in financing decreased $1.5 billion to $19.1 billion for the six months ended December 31,
2019, mainly due to other financing to facilitate the purchase of components. Cash used in investing increased $659
million to $7.8 billion for the six months ended December 31, 2019, mainly due to a $2.3 billion increase in cash used
for net investment purchases, sales, and maturities, offset in part by a $1.3 billion decrease in cash used for
acquisition of companies, net of cash acquired, and purchases of intangible and other assets.

Debt

We issue debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and
the low interest rate environment. The proceeds of these issuances were or will be used for general corporate
purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of
capital stock, acquisitions, and repayment of existing debt. Our last debt issuance occurred in fiscal year 2017. Refer
to Note 9 – Debt of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

Unearned Revenue

Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include
Software Assurance (“SA”) and cloud services. Unearned revenue is generally invoiced annually at the beginning of
each contract period for multi-year agreements and recognized ratably over the coverage period. Unearned revenue
also includes payments for other offerings for which we have been paid in advance and earn the revenue when we
transfer control of the product or service.

The following table outlines the expected future recognition of unearned revenue as of December 31, 2019:

(In millions)      
 
 

Three Months Ending        

 

March 31, 2020   $ 12,879 

June 30, 2020     8,287 
September 30, 2020 3,871 
December 31, 2020 2,306
Thereafter     3,878 
 
 

Total   $ 31,221 
       

If our customers choose to license cloud-based versions of our products and services rather than licensing
transaction-based products and services, the associated revenue will shift from being recognized at the time of the
transaction to being recognized over the subscription period or upon consumption, as applicable.

Share Repurchases

For the six months ended December 31, 2019 and 2018, we repurchased 61 million shares and 81 million shares of
our common stock for $8.6 billion and $8.7 billion, respectively, through our share repurchase program. All
repurchases were made using cash resources. Refer to Note 14 – Stockholders’ Equity of the Notes to Financial
Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

Dividends

Refer to Note 14 – Stockholders’ Equity of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for
further discussion.

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Off-Balance Sheet Arrangements

We provide indemnifications of varying scope and size to certain customers against claims of intellectual property
infringement made by third parties arising from the use of our products and certain other matters. Additionally, we
have agreed to cover damages resulting from breaches of certain security and privacy commitments in our cloud
business. In evaluating estimated losses on these obligations, we consider factors such as the degree of probability
of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations
did not have a material impact in our consolidated financial statements during the periods presented.

Other Planned Uses of Capital

We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of
technology, as well as continue making acquisitions that align with our business strategy. Additions to property and
equipment will continue, including new facilities, datacenters, and computer systems for research and development,
sales and marketing, support, and administrative staff. We expect capital expenditures to increase in coming years to
support growth in our cloud offerings. We have operating and finance leases for datacenters, corporate offices,
research and development facilities, retail stores, and certain equipment. We have not engaged in any related party
transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially
affect liquidity or the availability of capital resources.

Liquidity

As a result of the TCJA, we are required to pay a one-time transition tax on deferred foreign income not previously
subject to U.S. income tax. Under the TCJA, the transition tax is payable in interest-free installments over eight
years, with 8% due in each of the first five years, 15% in year six, 20% in year seven, and 25% in year eight. We
have paid transition tax of $3.2 billion, which included $1.2 billion during the six months ended December 31, 2019.
The remaining transition tax of $15.2 billion is payable over the next six years with a final payment in fiscal year
2026. During the six months ended December 31, 2019, we also paid $3.7 billion related to the transfer of intangible
properties that occurred in the fourth quarter of fiscal year 2019.

We expect existing cash, cash equivalents, short-term investments, cash flows from operations, and access to capital
markets to continue to be sufficient to fund our operating activities and cash commitments for investing and financing
activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax
related to the TCJA, for at least the next 12 months and thereafter for the foreseeable future.

RECENT ACCOUNTING GUIDANCE

Refer to Note 1 – Accounting Policies of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for
further discussion.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Our consolidated financial statements and accompanying notes are prepared in accordance with GAAP. Preparing
consolidated financial statements requires management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by
management’s application of accounting policies. Critical accounting policies for us include revenue recognition,
impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and
inventories.

Revenue Recognition

Our contracts with customers often include promises to transfer multiple products and services to a customer.
Determining whether products and services are considered distinct performance obligations that should be
accounted for separately versus together may require significant judgment. When a cloud-based service includes
both on-premises software licenses and cloud services, judgment is required to determine whether the software
license is considered distinct and accounted for separately, or not distinct and accounted for together with the cloud
service and recognized over time. Certain cloud services, primarily Office 365, depend on a significant level of
integration, interdependency, and interrelation between the desktop applications and cloud services, and are

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accounted for together as one performance obligation. Revenue from Office 365 is recognized ratably over the period
in which the cloud services are provided.

Judgment is required to determine the stand-alone selling price (“SSP") for each distinct performance obligation. We
use a single amount to estimate SSP for items that are not sold separately, including on-premises licenses sold with
SA or software updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell
each of the products and services separately and need to determine whether there is a discount to be allocated
based on the relative SSP of the various products and services.

In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we
determine the SSP using information that may include market conditions and other observable inputs. We typically
have more than one SSP for individual products and services due to the stratification of those products and services
by customers and circumstances. In these instances, we may use information such as the size of the customer and
geographic region in determining the SSP.

Due to the various benefits from and the nature of our SA program, judgment is required to assess the pattern of
delivery, including the exercise pattern of certain benefits across our portfolio of customers.

Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain
instances we estimate customer usage of our products and services, which are accounted for as variable
consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract
inception and updated at the end of each reporting period if additional information becomes available. Changes to
our estimated variable consideration were not material for the periods presented.

Impairment of Investment Securities

We review debt 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, and the duration and extent to which the fair value is less than cost. 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.
In addition, we 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 in
other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or
investee conditions deteriorate, we may incur future impairments.

Equity investments without readily determinable fair values are written down to fair value if a qualitative assessment
indicates that the investment is impaired and the fair value of the investment is less than carrying value. We perform
a qualitative assessment on a quarterly basis. We are required to estimate the fair value of the investment to
determine the amount of the impairment loss. Once an investment is determined to be impaired, an impairment
charge is recorded in other income (expense), net.

Goodwill

We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business
combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative
fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one
level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or
circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying
value. These events or circumstances could include a significant change in the business climate, legal factors,
operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit.

Application of the goodwill impairment test requires judgment, including the identification of reporting units,
assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of
the fair value of each reporting unit. The fair value of each reporting unit is estimated primarily through the use of a
discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash
flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business,

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estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of
capital.

The estimates used to calculate the fair value of a reporting unit change from year to year based on operating
results, market conditions, and other factors. Changes in these estimates and assumptions could materially affect the
determination of fair value and goodwill impairment for each reporting unit.

Research and Development Costs

Costs incurred internally in researching and developing a computer software product are charged to expense until
technological feasibility has been established for the product. Once technological feasibility is established, software
costs are capitalized until the product is available for general release to customers. Judgment is required in
determining when technological feasibility of a product is established. We have determined that technological
feasibility for our software products is reached after all high-risk development issues have been resolved through
coding and testing. Generally, this occurs shortly before the products are released to production. The amortization of
these costs is included in cost of revenue over the estimated life of the products.

Legal and Other Contingencies

The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An estimated
loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable
that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably
estimated. In determining whether a loss should be accrued we evaluate, among other factors, the degree of
probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes
in these factors could materially impact our consolidated financial statements.

Income Taxes

The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the
current year, and deferred tax liabilities and assets for the future tax consequences of events that have been
recognized in an entity’s financial statements or tax returns. We recognize the tax benefit from an uncertain tax
position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities,
based on the technical merits of the position. The tax benefits recognized in the financial statements from such a
position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon
ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and
liabilities, classification of deferred income tax assets and liabilities, accounting for interest and penalties associated
with tax positions, and income tax disclosures. Judgment is required in assessing the future tax consequences of
events that have been recognized in our consolidated financial statements or tax returns. Variations in the actual
outcome of these future tax consequences could materially impact our consolidated financial statements.

Inventories

Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials,
labor, and manufacturing overhead related to the purchase and production of inventories. Net realizable value is the
estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review
inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our
inventory. These reviews include analysis of demand forecasts, product life cycle status, product development plans,
current sales levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below
carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.

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Item 3, 4

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

RISKS

We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, and equity prices. We use
derivatives instruments to manage these risks, however, they may still impact our consolidated financial statements.

Foreign Currency

Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our foreign
currency exposures daily to maximize the economic effectiveness of our foreign currency positions, including
hedges. Principal currency exposures include the Euro, Japanese yen, British pound, Canadian dollar, and
Australian dollar.

Interest Rate

Securities held in our fixed-income portfolio are subject to different interest rate risks based on their maturities. We
manage the average maturity of the fixed-income portfolio to achieve economic returns that correlate to certain global
fixed-income indices.

Credit

Our fixed-income portfolio is diversified and consists primarily of investment-grade securities. We manage credit
exposures relative to broad-based indices and to facilitate portfolio diversification.

Equity

Securities held in our equity investments portfolio are subject to price risk. 

SENSITIVITY ANALYSIS

The following table sets forth the potential loss in future earnings or fair values, including associated derivatives,
resulting from hypothetical changes in relevant market rates or prices:

(In millions)

December 31,
Risk Categories Hypothetical Change 2019 Impact

Foreign currency—Revenue 10% decrease in foreign exchange rates  $ (4,245)   Earnings  

Foreign currency—Investments   10% decrease in foreign exchange rates    (130)   Fair Value  
Interest rate   100 basis point increase in U.S. treasury interest rates    (3,726)   Fair Value  
Credit   100 basis point increase in credit spreads    (221)   Fair Value  
Equity   10% decrease in equity market prices    (260)   Earnings

ITEM 4. CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief
Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by
Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief
Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are
effective. There were no changes in our internal control over financial reporting during the quarter ended December
31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial
reporting.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS
Refer to Note 13 – Contingencies of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for
information regarding legal proceedings in which we are involved.

ITEM 1A. RISK FACTORS

Our operations and financial results are subject to various risks and uncertainties, including those described below,
that could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of
our common stock.

We face intense competition across all markets for our products and services, which may lead to lower
revenue or operating margins.

Competition in the technology sector

Our competitors range in size from diversified global companies with significant research and development resources
to small, specialized firms whose narrower product lines may let them be more effective in deploying technical,
marketing, and financial resources. Barriers to entry in many of our businesses are low and many of the areas in
which we compete evolve rapidly with changing and disruptive technologies, shifting user needs, and frequent
introductions of new products and services. Our ability to remain competitive depends on our success in making
innovative products, devices, and services that appeal to businesses and consumers.

Competition among platform-based ecosystems

An important element of our business model has been to create platform-based ecosystems on which many
participants can build diverse solutions. A well-established ecosystem creates beneficial network effects among
users, application developers, and the platform provider that can accelerate growth. Establishing significant scale in
the marketplace is necessary to achieve and maintain attractive margins. We face significant competition from firms
that provide competing platforms.
• A competing vertically-integrated model, in which a single firm controls the software and hardware
elements of a product and related services, has succeeded with some consumer products such as
personal computers, tablets, phones, gaming consoles, wearables, and other endpoint devices.
Competitors pursuing this model also earn revenue from services integrated with the hardware and
software platform, including applications and content sold through their integrated marketplaces. They
may also be able to claim security and performance benefits from their vertically integrated offer. We also
offer some vertically-integrated hardware and software products and services. To the extent we shift a
portion of our business to a vertically integrated model we increase our cost of revenue and reduce our
operating margins.

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• We derive substantial revenue from licenses of Windows operating systems on PCs. We face significant
competition from competing platforms developed for new devices and form factors such as smartphones
and tablet computers. These devices compete on multiple bases including price and the perceived utility
of the device and its platform. Users are increasingly turning to these devices to perform functions that in
the past were performed by personal computers. Even if many users view these devices as
complementary to a personal computer, the prevalence of these devices may make it more difficult to
attract application developers to our PC operating system platforms. Competing with operating systems
licensed at low or no cost may decrease our PC operating system margins. Popular products or services
offered on competing platforms could increase their competitive strength. In addition, some of our devices
compete with products made by our original equipment manufacturer (“OEM”) partners, which may affect
their commitment to our platform.

• Competing platforms have content and application marketplaces with scale and significant installed
bases. The variety and utility of content and applications available on a platform are important to device
purchasing decisions. Users may incur costs to move data and buy new content and applications when
switching platforms. To compete, we must successfully enlist developers to write applications for our
platform and ensure that these applications have high quality, security, customer appeal, and value.
Efforts to compete

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• with competitors’ content and application marketplaces may increase our cost of revenue and lower our
operating margins.

Business model competition

Companies compete with us based on a growing variety of business models.

• Even as we transition more of our business to infrastructure-, platform-, and software-as-a-service
business model, the license-based proprietary software model generates a substantial portion of our
software revenue. We bear the costs of converting original ideas into software products through
investments in research and development, offsetting these costs with the revenue received from licensing
our products. Many of our competitors also develop and sell software to businesses and consumers under
this model.
• Other competitors develop and offer free applications, online services and content, and make money by
selling third-party advertising. Advertising revenue funds development of products and services these
competitors provide to users at no or little cost, competing directly with our revenue-generating products.
• Some companies compete with us by modifying and then distributing open source software at little or no
cost to end users, and earning revenue on advertising or integrated products and services. These firms do
not bear the full costs of research and development for the open source software. Some open source
software mimics the features and functionality of our products.

The competitive pressures described above may cause decreased sales volumes, price reductions, and/or increased
operating costs, such as for research and development, marketing, and sales incentives. This may lead to lower
revenue, gross margins, and operating income.

Our increasing focus on cloud-based services presents execution and competitive risks. A growing part of our
business involves cloud-based services available across the spectrum of computing devices. Our strategic vision is
to compete and grow by building best-in-class platforms and productivity services for an intelligent cloud and an
intelligent edge infused with AI. At the same time, our competitors are rapidly developing and deploying cloud-based
services for consumers and business customers. Pricing and delivery models are evolving. Devices and form factors
influence how users access services in the cloud and sometimes the user’s choice of which cloud-based services to
use. We are devoting significant resources to develop and deploy our cloud-based strategies. The Windows
ecosystem must continue to evolve with this changing environment. We are undertaking cultural and organizational
changes to drive accountability and eliminate obstacles to innovation. Our intelligent cloud and intelligent edge
worldview is connected with the growth of the Internet of Things (“IoT”). Our success in the IoT will depend on the
level of adoption of our offerings such as Microsoft Azure, Azure Stack, Azure IoT Edge, and Azure Sphere. We may
not establish market share sufficient to achieve scale necessary to achieve our business objectives.

Besides software development costs, we are incurring costs to build and maintain infrastructure to support cloud
computing services. These costs will reduce the operating margins we have previously achieved. Whether we
succeed in cloud-based services depends on our execution in several areas, including:
• Continuing to bring to market compelling cloud-based experiences that generate increasing traffic and
market share.
• Maintaining the utility, compatibility, and performance of our cloud-based services on the growing array of
computing devices, including PCs, smartphones, tablets, gaming consoles, and other devices, as well as
sensors and other endpoints.
• Continuing to enhance the attractiveness of our cloud platforms to third-party developers.
• Ensuring our cloud-based services meet the reliability expectations of our customers and maintain the
security of their data.
• Making our suite of cloud-based services platform-agnostic, available on a wide range of devices and
ecosystems, including those of our competitors.

It is uncertain whether our strategies will attract the users or generate the revenue required to succeed. If we are not
effective in executing organizational and technical changes to increase efficiency and accelerate innovation, or if we
fail to generate sufficient usage of our new products and services, we may not grow revenue in line with the
infrastructure and development investments described above. This may negatively impact gross margins and
operating income.
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We make significant investments in products and services that may not achieve expected returns. We will
continue to make significant investments in research, development, and marketing for existing products, services,
and technologies, including the Windows operating system, Microsoft 365, Office, Bing, Microsoft SQL Server,
Windows Server, Azure, Office 365, Xbox Live, Mixer, LinkedIn, and other products and services. We also invest in
the development and acquisition of a variety of hardware for productivity, communication, and entertainment
including PCs, tablets, gaming devices, and HoloLens. Investments in new technology are speculative. Commercial
success depends on many factors, including innovativeness, developer support, and effective distribution and
marketing. If customers do not perceive our latest offerings as providing significant new functionality or other value,
they may reduce their purchases of new software and hardware products or upgrades, unfavorably affecting
revenue. We may not achieve significant revenue from new product, service, and distribution channel investments for
several years, if at all. New products and services may not be profitable, and even if they are profitable, operating
margins for some new products and businesses will not be as high as the margins we have experienced historically.
We may not get engagement in certain features, like Microsoft Edge and Bing, that drive post-sale monetization
opportunities. Our data handling practices across our products and services will continue to be under scrutiny and
perceptions of mismanagement, driven by regulatory activity or negative public reaction to our practices or product
experiences, which could negatively impact product and feature adoption, product design, and product quality.

Developing new technologies is complex. It can require long development and testing periods. Significant delays in
new releases or significant problems in creating new products or services could adversely affect our revenue.

Acquisitions, joint ventures, and strategic alliances may have an adverse effect on our business.  We expect
to continue making acquisitions and entering into joint ventures and strategic alliances as part of our long-term
business strategy. In December 2016, we completed our acquisition of LinkedIn Corporation for $27.0 billion, and in
October 2018, we completed our acquisition of GitHub, Inc. for $7.5 billion. These acquisitions and other transactions
and arrangements involve significant challenges and risks, including that they do not advance our business strategy,
that we get an unsatisfactory return on our investment, that we have difficulty integrating and retaining new
employees, business systems, and technology, or that they distract management from our other businesses. If an
arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early
termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in
part on our ability to leverage them to enhance our existing products and services or develop compelling new ones. It
may take longer than expected to realize the full benefits from these transactions and arrangements such as
increased revenue or enhanced efficiencies, or the benefits may ultimately be smaller than we expected. These
events could adversely affect our consolidated financial statements.

If our goodwill or amortizable intangible assets become impaired, we may be required to record a significant
charge to earnings. We acquire other companies and intangible assets and may not realize all the economic benefit
from those acquisitions, which could cause an impairment of goodwill or intangibles. We review our amortizable
intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be
recoverable. We test goodwill for impairment at least annually. Factors that may be a change in circumstances,
indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable, include a
decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in
industry segments in which we participate. We have in the past recorded, and may in the future be required to record
a significant charge in our consolidated financial statements during the period in which any impairment of our
goodwill or amortizable intangible assets is determined, negatively affecting our results of operations. Our acquisition
of LinkedIn resulted in a significant increase in our goodwill and intangible asset balances.

Cyberattacks and security vulnerabilities could lead to reduced revenue, increased costs, liability claims, or
harm to our reputation or competitive position.

Security of our information technology

Threats to IT security can take a variety of forms. Individual and groups of hackers and sophisticated organizations,
including state-sponsored organizations or nation-states, continuously undertake attacks that pose threats to our
customers and our IT. These actors may use a wide variety of methods, which may include developing and deploying
malicious software or exploiting vulnerabilities in hardware, software, or other infrastructure in order to attack our
products and services or gain access to our networks and datacenters, using social engineering techniques to induce
our employees, users, partners, or customers to disclose passwords or other sensitive information or take other
actions to gain access to our data or our users’ or customers’ data, or acting in a coordinated manner to launch
distributed denial of service or other coordinated attacks. Inadequate account security practices may also result in
unauthorized access to confidential data. For example, system administrators may fail to timely remove employee
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account access when no longer appropriate. Employees or third parties may intentionally compromise our or our
users’ security or systems, or reveal confidential information.

Cyberthreats are constantly evolving, increasing the difficulty of detecting and successfully defending against them.
We may have no current capability to detect certain vulnerabilities, which may allow them to persist in the
environment over long periods of time. Cyberthreats can have cascading impacts that unfold with increasing speed
across our internal networks and systems and those of our partners and customers. Breaches of our facilities,
network, or data security could disrupt the security of our systems and business applications, impair our ability to
provide services to our customers and protect the privacy of their data, result in product development delays,
compromise confidential or technical business information harming our reputation or competitive position, result in
theft or misuse of our intellectual property or other assets, require us to allocate more resources to improved
technologies, or otherwise adversely affect our business.

In addition, our internal IT environment continues to evolve. Often, we are early adopters of new devices and
technologies. We embrace new ways of sharing data and communicating internally and with partners and customers
using methods such as social networking and other consumer-oriented technologies. Our business policies and
internal security controls may not keep pace with these changes as new threats emerge.

Security of our products, services, devices, and customers’ data

The security of our products and services is important in our customers’ decisions to purchase or use our products or
services. Security threats are a significant challenge to companies like us whose business is providing technology
products and services to others. Threats to our own IT infrastructure can also affect our customers. Customers using
our cloud-based services rely on the security of our infrastructure, including hardware and other elements provided
by third parties, to ensure the reliability of our services and the protection of their data. Adversaries tend to focus their
efforts on the most popular operating systems, programs, and services, including many of ours, and we expect that to
continue. Adversaries that acquire user account information at other companies can use that information to
compromise our users’ accounts where accounts share the same attributes as passwords. Inadequate account
security practices may also result in unauthorized access. User activity may also result in ransomware or other
malicious software impacting a customer’s use of our products or services. We are also increasingly incorporating
open source software into our products. There may be vulnerabilities in open source software that may make our
products susceptible to cyberattacks.

To defend against security threats to our internal IT systems, our cloud-based services, and our customers’ systems,
we must continuously engineer more secure products and services, enhance security and reliability features, improve
the deployment of software updates to address security vulnerabilities in our own products as well as those provided
by others, develop mitigation technologies that help to secure customers from attacks even when software updates
are not deployed, maintain the digital security infrastructure that protects the integrity of our network, products, and
services, and provide security tools such as firewalls and anti-virus software and information about the need to
deploy security measures and the impact of doing so.

The cost of these steps could reduce our operating margins. If we fail to do these things well, actual or perceived
security vulnerabilities in our products and services, data corruption issues, or reduced performance could harm our
reputation and lead customers to reduce or delay future purchases of products or subscriptions to services, or to use
competing products or services. Customers may also spend more on protecting their existing computer systems from
attack, which could delay adoption of additional products or services. Customers may fail to update their systems,
continue to run software or operating systems we no longer support, or may fail timely to install or enable security
patches. Any of these could adversely affect our reputation and revenue. Actual or perceived vulnerabilities may lead
to claims against us. Our license agreements typically contain provisions that eliminate or limit our exposure to
liability, but there is no assurance these provisions will withstand legal challenges. At times, to achieve commercial
objectives, we may enter into agreements with larger liability exposure to customers.

As illustrated by the Spectre and Meltdown threats, our products operate in conjunction with and are dependent on
products and components across a broad ecosystem of third parties. If there is a security vulnerability in one of these
components, and if there is a security exploit targeting it, we could face increased costs, liability claims, reduced
revenue, or harm to our reputation or competitive position.

Disclosure and misuse of personal data could result in liability and harm our reputation. As we continue to
grow the number and scale of our cloud-based offerings, we store and process increasingly large amounts of
personally identifiable information of our customers and users. The continued occurrence of high-profile data

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breaches provides evidence of an external environment increasingly hostile to information security. Despite our
efforts to improve the security controls across our business groups and geographies, it is possible our security
controls over personal data, our training of employees and third parties on data security, and other practices we
follow may not prevent the improper disclosure or misuse of customer or user data we or our vendors store and
manage. In addition, third parties who have limited access to our customer or user data may use this data in
unauthorized ways. Improper disclosure or misuse could harm our reputation, lead to legal exposure to customers or
users, or subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue.
Our software products and services also enable our customers and users to store and process personal data on-
premises or, increasingly, in a cloud-based environment we host. Government authorities can sometimes require us
to produce customer or user data in response to valid legal orders. In the U.S. and elsewhere, we advocate for
transparency concerning these requests and appropriate limitations on government authority to compel disclosure.
Despite our efforts to protect customer and user data, perceptions that the collection, use, and retention of personal
information is not satisfactorily protected could inhibit sales of our products or services, and could limit adoption of
our cloud-based solutions by consumers, businesses, and government entities. Additional security measures we may
take to address customer or user concerns, or constraints on our flexibility to determine where and how to operate
datacenters in response to customer or user expectations or governmental rules or actions, may cause higher
operating expenses or hinder growth of our products and services.

We may not be able to protect information in our products and services from use by others. LinkedIn and
other Microsoft products and services contain valuable information and content protected by contractual restrictions
or technical measures. In certain cases, we have made commitments to our members and users to limit access to or
use of this information. Changes in the law or interpretations of the law may weaken our ability to prevent third
parties from scraping or gathering information or content through use of bots or other measures and using it for their
own benefit, thus diminishing the value of our products and services.

Abuse of our platforms may harm our reputation or user engagement.

Advertising, professional, and social platform abuses

For platform products and services that provide content or host ads that come from or can be influenced by third
parties, including GitHub, LinkedIn, Microsoft Advertising, MSN, and Xbox Live, our reputation or user engagement
may be negatively affected by activity that is hostile or inappropriate. This activity may come from users
impersonating other people or organizations, use of our products or services to spread terrorist or violent extremist
content or to disseminate information that may be viewed as misleading or intended to manipulate the opinions of our
users, or the use of our products or services that violates our terms of service or otherwise for objectionable or illegal
ends. Preventing or responding to these actions may require us to make substantial investments in people and
technology and these investments may not be successful, adversely affecting our business and consolidated
financial statements.

Harmful content online

Our hosted consumer services as well as our enterprise services may be used by third parties to disseminate harmful
or illegal content in violation of our terms or applicable law. We may not proactively discover such content due to
scale and the limitations of existing technologies, and when discovered by users, such content may negatively affect
our reputation, our brands, and user engagement. Regulations and other initiatives to make platforms responsible for
preventing or eliminating harmful content online are gaining momentum and we expect this to continue. We may be
subject to enhanced regulatory oversight, substantial liability, or reputational damage if we fail to comply with content
moderation regulations, adversely affecting our business and consolidated financial statements.

The development of the IoT presents security, privacy, and execution risks. To support the growth of the
intelligent cloud and the intelligent edge, we are developing products, services, and technologies to power the IoT, a
network of distributed and interconnected devices employing sensors, data, and computing capabilities including AI.
The IoT’s great potential also carries substantial risks. IoT products and services may contain defects in design,
manufacture, or operation, that make them insecure or ineffective for their intended purposes. An IoT solution has
multiple layers of hardware, sensors, processors, software, and firmware, several of which we may not develop or
control. Each layer, including the weakest layer, can impact the security of the whole system. Many IoT devices have
limited interfaces and ability to be updated or patched. IoT solutions may collect large amounts of data, and our
handling of IoT data may not satisfy customers or regulatory requirements. IoT scenarios may increasingly affect
personal health and safety. If IoT solutions that include our technologies do not work as intended, violate the law, or

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harm individuals or businesses, we may be subject to legal claims or enforcement actions. These risks, if realized,
may increase our costs, damage our reputation or brands, or negatively impact our revenues or margins.

Issues in the use of AI in our offerings may result in reputational harm or liability . We are building AI into many
of our offerings and we expect this element of our business to grow. We envision a future in which AI operating in our
devices, applications, and the cloud helps our customers be more productive in their work and personal lives. As with
many disruptive innovations, AI presents risks and challenges that could affect its adoption, and therefore our
business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Inappropriate or
controversial data practices by Microsoft or others could impair the acceptance of AI solutions. These deficiencies
could undermine the decisions, predictions, or analysis AI applications produce, subjecting us to competitive harm,
legal liability, and brand or reputational harm. Some AI scenarios present ethical issues. If we enable or offer AI
solutions that are controversial because of their impact on human rights, privacy, employment, or other social issues,
we may experience brand or reputational harm.

We may have excessive outages, data losses, and disruptions of our online services if we fail to maintain an
adequate operations infrastructure. Our increasing user traffic, growth in services, and the complexity of our
products and services demand more computing power. We spend substantial amounts to build, purchase, or lease
datacenters and equipment and to upgrade our technology and network infrastructure to handle more traffic on our
websites and in our datacenters. These demands continue to increase as we introduce new products and services
and support the growth of existing services such as Bing, Azure, Microsoft Account services, Office 365, Microsoft
Teams, Dynamics 365, OneDrive, SharePoint Online, Skype, Xbox Live, and Outlook.com. We are rapidly growing
our business of providing a platform and back-end hosting for services provided by third parties to their end users.
Maintaining, securing, and expanding this infrastructure is expensive and complex. It requires that we maintain an
Internet connectivity infrastructure that is robust and reliable within competitive and regulatory constraints that
continue to evolve. Inefficiencies or operational failures, including temporary or permanent loss of customer data or
insufficient Internet connectivity, could diminish the quality of our products, services, and user experience resulting in
contractual liability, claims by customers and other third parties, regulatory actions, damage to our reputation, and
loss of current and potential users, subscribers, and advertisers, each of which may adversely impact our
consolidated financial statements.

We may experience quality or supply problems. Our hardware products such as Xbox consoles, Surface devices,
and other devices we design, manufacture, and market are highly complex and can have defects in design,
manufacture, or associated software. We could incur significant expenses, lost revenue, and reputational harm as a
result of recalls, safety alerts, or product liability claims if we fail to prevent, detect, or address such issues through
design, testing, or warranty repairs.

Our software products and services also may experience quality or reliability problems. The highly sophisticated
software we develop may contain bugs and other defects that interfere with their intended operation. Our customers
increasingly rely on us for critical functions, potentially magnifying the impact of quality or reliability issues. Any
defects we do not detect and fix in pre-release testing could cause reduced sales and revenue, damage to our
reputation, repair or remediation costs, delays in the release of new products or versions, or legal liability. Although
our license agreements typically contain provisions that eliminate or limit our exposure to liability, there is no
assurance these provisions will withstand legal challenge.

We acquire some device and datacenter components from sole suppliers. Our competitors use some of the same
suppliers and their demand for hardware components can affect the capacity available to us. If a component from a
sole-source supplier is delayed or becomes unavailable, whether because of supplier capacity constraint, industry
shortages, legal or regulatory changes, or other reasons, we may not obtain timely replacement supplies, resulting in
reduced sales or inadequate datacenter capacity. Component shortages, excess or obsolete inventory, or price
reductions resulting in inventory adjustments may increase our cost of revenue. Xbox consoles, Surface devices,
datacenter servers, and other hardware are assembled in Asia and other geographies that may be subject to
disruptions in the supply chain, resulting in shortages that would affect our revenue and operating margins. These
same risks would apply to any other hardware and software products we may offer.

We may not be able to protect our source code from copying if there is an unauthorized disclosure. Source
code, the detailed program commands for our operating systems and other software programs, is critical to our
business. Although we license portions of our application and operating system source code to several licensees, we
take significant measures to protect the secrecy of large portions of our source code. If our source code leaks, we
might lose future trade secret protection for that code. It may then become easier for third parties to compete with our

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products by copying functionality, which could adversely affect our revenue and operating margins. Unauthorized
disclosure of source code also could increase the security risks described elsewhere in these risk factors.

Legal changes, our evolving business model, piracy, and other factors may decrease the value of our
intellectual property. Protecting our intellectual property rights and combating unlicensed copying and use of our
software and other intellectual property on a global basis is difficult. While piracy adversely affects U.S. revenue, the
impact on revenue from outside the U.S. is more significant, particularly countries in which the legal system provides
less protection for intellectual property rights. Our revenue in these markets may grow more slowly than the
underlying device market. Similarly, the absence of harmonized patent laws makes it more difficult to ensure
consistent respect for patent rights. Throughout the world, we educate users about the benefits of licensing genuine
products and obtaining indemnification benefits for intellectual property risks, and we educate lawmakers about the
advantages of a business climate where intellectual property rights are protected. Reductions in the legal protection
for software intellectual property rights could adversely affect revenue.

We expend significant resources to patent the intellectual property we create with the expectation that we will
generate revenues by incorporating that intellectual property in our products or services or, in some instances, by
licensing our patents to others in return for a royalty. Changes in the law may continue to weaken our ability to
prevent the use of patented technology or collect revenue for licensing our patents. These include legislative
changes and regulatory actions that make it more difficult to obtain injunctions, and the increasing use of legal
process to challenge issued patents. Similarly, licensees of our patents may fail to satisfy their obligations to pay us
royalties, or may contest the scope and extent of their obligations. The royalties we can obtain to monetize our
intellectual property may decline because of the evolution of technology, selling price changes in products using
licensed patents, or the difficulty of discovering infringements. Finally, our increasing engagement with open source
software will also cause us to license our intellectual property rights broadly in certain situations and may negatively
impact revenue.

Third parties may claim we infringe their intellectual property rights. From time to time, others claim we infringe
their intellectual property rights. The number of these claims may grow because of constant technological change in
the markets in which we compete, the extensive patent coverage of existing technologies, the rapid rate of issuance
of new patents, and our offering of first-party devices, such as Microsoft Surface. To resolve these claims, we may
enter into royalty and licensing agreements on terms that are less favorable than currently available, stop selling or
redesign affected products or services, or pay damages to satisfy indemnification commitments with our customers.
These outcomes may cause operating margins to decline. Besides money damages, in some jurisdictions plaintiffs
can seek injunctive relief that may limit or prevent importing, marketing, and selling our products or services that
have infringing technologies. In some countries, such as Germany, an injunction can be issued before the parties
have fully litigated the validity of the underlying patents. We have paid significant amounts to settle claims related to
the use of technology and intellectual property rights and to procure intellectual property rights as part of our strategy
to manage this risk, and may continue to do so.

We have claims and lawsuits against us that may result in adverse outcomes. We are subject to a variety of
claims and lawsuits. These claims may arise from a wide variety of business practices and initiatives, including major
new product releases such as Windows 10, significant business transactions, warranty or product claims, and
employment practices. Adverse outcomes in some or all of these claims may result in significant monetary damages
or injunctive relief that could adversely affect our ability to conduct our business. The litigation and other claims are
subject to inherent uncertainties and management’s view of these matters may change in the future. A material
adverse impact in our consolidated financial statements could occur for the period in which the effect of an
unfavorable outcome becomes probable and reasonably estimable.

Government litigation and regulatory activity relating to competition rules may limit how we design and
market our products. As a leading global software and device maker, government agencies closely scrutinize us
under U.S. and foreign competition laws. Governments are actively enforcing competition laws and regulations, and
this includes scrutiny in potentially large markets such as the European Union (“EU”), the U.S., and China. Some
jurisdictions also allow competitors or consumers to assert claims of anti-competitive conduct. U.S. federal and state
antitrust authorities have previously brought enforcement actions and continue to scrutinize our business.

The European Commission (“the Commission”) closely scrutinizes the design of high-volume Microsoft products and
the terms on which we make certain technologies used in these products, such as file formats, programming
interfaces, and protocols, available to other companies. Flagship product releases such as Windows 10 can receive
significant scrutiny under competition laws. For example, in 2004, the Commission ordered us to create new versions
of our Windows operating system that do not include certain multimedia technologies and to provide our competitors
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with specifications for how to implement certain proprietary Windows communications protocols in their own
products. In 2009, the Commission accepted a set of commitments we offered to address the Commission’s
concerns relating to competition in web browsing software, including an undertaking to address Commission
concerns relating to interoperability. The web browsing commitments expired in 2014. The remaining obligations may
limit our ability to innovate in Windows or other products in the future, diminish the developer appeal of the Windows
platform, and increase our product development costs. The availability of licenses related to protocols and file
formats may enable competitors to develop software products that better mimic the functionality of our products,
which could hamper sales of our products.

Our portfolio of first-party devices continues to grow; at the same time our OEM partners offer a large variety of
devices for our platforms. As a result, increasingly we both cooperate and compete with our OEM partners, creating a
risk that we fail to do so in compliance with competition rules. Regulatory scrutiny in this area may increase. Certain
foreign governments, particularly in China and other countries in Asia, have advanced arguments under their
competition laws that exert downward pressure on royalties for our intellectual property.

Government regulatory actions and court decisions such as these may result in fines, or hinder our ability to provide
the benefits of our software to consumers and businesses, reducing the attractiveness of our products and the
revenue that come from them. New competition law actions could be initiated, potentially using previous actions as
precedent. The outcome of such actions, or steps taken to avoid them, could adversely affect us in a variety of ways,
including:
• We may have to choose between withdrawing products from certain geographies to avoid fines or
designing and developing alternative versions of those products to comply with government rulings, which
may entail a delay in a product release and removing functionality that customers want or on which
developers rely.
• We may be required to make available licenses to our proprietary technologies on terms that do not reflect
their fair market value or do not protect our associated intellectual property.
• We are subject to a variety of ongoing commitments because of court or administrative orders, consent
decrees, or other voluntary actions we have taken. If we fail to comply with these commitments, we may
incur litigation costs and be subject to substantial fines or other remedial actions.
• Our ability to realize anticipated Windows 10 post-sale monetization opportunities may be limited.

Our global operations subject us to potential liability under anti-corruption, trade protection, and other laws
and regulations. The Foreign Corrupt Practices Act (“FCPA”) and other anti-corruption laws and regulations (“Anti-
Corruption Laws”) prohibit corrupt payments by our employees, vendors, or agents, and the accounting provisions of
the FCPA require us to maintain accurate books and records and adequate internal controls. From time to time, we
receive inquiries from authorities in the U.S. and elsewhere which may be based on reports from employees and
others about our business activities outside the U.S. and our compliance with Anti-Corruption Laws. Periodically, we
receive such reports directly and investigate them. On July 22, 2019, our Hungarian subsidiary entered into a non-
prosecution agreement (“NPA”) with the U.S. Department of Justice (“DOJ”) and we agreed to the terms of a cease
and desist order with the Securities and Exchange Commission. These agreements required us to pay $25.3 million
in monetary penalties, disgorgement, and interest pertaining to activities at Microsoft’s subsidiary in Hungary. The
NPA, which has a three-year term, also contains certain ongoing compliance requirements, including the obligations
to disclose to the DOJ issues that may implicate the FCPA and to cooperate in any inquiries. Most countries in which
we operate also have competition laws that prohibit competitors from colluding or otherwise attempting to reduce
competition between themselves. While we devote substantial resources to our U.S. and international compliance
programs and have implemented policies, training, and internal controls designed to reduce the risk of corrupt
payments and collusive activity, our employees, vendors, or agents may violate our policies. Our failure to comply
with Anti-Corruption Laws or competition laws could result in significant fines and penalties, criminal sanctions
against us, our officers, or our employees, prohibitions on the conduct of our business, and damage to our
reputation. Operations outside the U.S. may be affected by changes in trade protection laws, policies, sanctions, and
other regulatory requirements affecting trade and investment. We may be subject to legal liability and reputational
damage if we sell goods or services in violation of U.S. trade sanctions on restricted entities or countries such as
Iran, North Korea, Cuba, Sudan, and Syria.

Other regulatory areas that may apply to our products and online services offerings include user privacy,
telecommunications, data storage and protection, and online content. For example, some regulators are taking the
position that our offerings such as Teams and Skype are covered by existing laws regulating telecommunications
services, and some new laws are defining more of our services as regulated telecommunications services. This trend
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may continue and will result in these offerings being subjected to additional data protection, security, and law
enforcement surveillance obligations. Data protection authorities may assert that our collection, use, and
management of customer data is inconsistent with their laws and regulations. Legislative or regulatory action relating
to cybersecurity requirements may increase the costs to develop, implement, or secure our products and services.
Legislative or regulatory action could also emerge in the area of AI and content moderation, increasing costs or
restricting opportunity. Applying these laws and regulations to our business is often unclear, subject to change over
time, and sometimes may conflict from jurisdiction to jurisdiction. Additionally, these laws and governments’ approach
to their enforcement, and our products and services, are continuing to evolve. Compliance with these types of
regulation may involve significant costs or require changes in products or business practices that result in reduced
revenue. Noncompliance could result in the imposition of penalties or orders we stop the alleged noncompliant
activity.

We strive to empower all people and organizations to achieve more, and accessibility of our products is an important
aspect of this goal. There is increasing pressure from advocacy groups, regulators, competitors, customers, and
other stakeholders to make technology more accessible. If our products do not meet customer expectations or
emerging global accessibility requirements, we could lose sales opportunities or face regulatory actions

Laws and regulations relating to the handling of personal data may impede the adoption of our services or
result in increased costs, legal claims, fines against us, or reputational damage. The growth of our Internet-
and cloud-based services internationally relies increasingly on the movement of data across national boundaries.
Legal requirements relating to the collection, storage, handling, and transfer of personal data continue to evolve. For
example, the EU and the U.S. formally entered into a new framework in July 2016 that provides a mechanism for
companies to transfer data from EU member states to the U.S. This framework, called the Privacy Shield, is intended
to address shortcomings identified by the European Court of Justice in a predecessor mechanism. The Privacy
Shield and other mechanisms are currently subject to challenges in European courts, which may lead to uncertainty
about the legal basis for data transfers across the Atlantic. The Privacy Shield and other potential rules on the flow of
data across borders could increase the cost and complexity of delivering our products and services in some markets.
In May 2018, a new EU law governing data practices and privacy, the General Data Protection Regulation (“GDPR”),
became effective. The law, which applies to all of our activities conducted from an establishment in the EU or related
to products and services offered in the EU, imposes a range of new compliance obligations regarding the handling of
personal data. Engineering efforts to build new capabilities to facilitate compliance with the law have entailed
substantial expense and the diversion of engineering resources from other projects and may continue to do so. We
might experience reduced demand for our offerings if we are unable to engineer products that meet our legal duties
or help our customers meet their obligations under the GDPR or other data regulations, or if the changes we
implement to comply with the GDPR make our offerings less attractive. The GDPR imposes significant new
obligations and compliance with these obligations depends in part on how particular regulators interpret and apply
them. If we fail to comply with the GDPR, or if regulators assert we have failed to comply with the GDPR, it may lead
to regulatory enforcement actions, which can result in monetary penalties of up to 4% of worldwide revenue, private
lawsuits, or reputational damage. In the U.S., California has adopted, and several states are considering adopting,
laws and regulations imposing obligations regarding the handling of personal data.

The Company’s investment in gaining insights from data is becoming central to the value of the services we deliver to
customers, to our operational efficiency and key opportunities in monetization, customer perceptions of quality, and
operational efficiency. Our ability to use data in this way may be constrained by regulatory developments that impede
realizing the expected return from this investment. Ongoing legal analyses, reviews, and inquiries by regulators of
Microsoft practices, or relevant practices of other organizations, may result in burdensome or inconsistent
requirements, including data sovereignty and localization requirements, affecting the location, movement, collection,
and use of our customer and internal employee data as well as the management of that data. Compliance with
applicable laws and regulations regarding personal data may require changes in services, business practices, or
internal systems that result in increased costs, lower revenue, reduced efficiency, or greater difficulty in competing
with foreign-based firms. Compliance with data regulations might limit our ability to innovate or offer certain features
and functionality in some jurisdictions where we operate. Failure to comply with existing or new rules may result in
significant penalties or orders to stop the alleged noncompliant activity, as well as negative publicity and diversion of
management time and effort.

We may have additional tax liabilities. We are subject to income taxes in the U.S. and many foreign jurisdictions.
Significant judgment is required in determining our worldwide provision for income taxes. In the course of our
business, there are many transactions and calculations where the ultimate tax determination is uncertain. For
example, compliance with the 2017 United States Tax Cuts and Jobs Act (“TCJA”) may require the collection of

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information not regularly produced within the Company, the use of estimates in our consolidated financial statements,
and the exercise of significant judgment in accounting for its provisions. As regulations and guidance evolve with
respect to the TCJA, and as we gather more information and perform more analysis, our results may differ from
previous estimates and may materially affect our consolidated financial statements.

We regularly are under audit by tax authorities in different jurisdictions. Although we believe that our provision for
income taxes and our tax estimates are reasonable, tax authorities may disagree with certain positions we have
taken. In addition, economic and political pressures to increase tax revenue in various jurisdictions may make
resolving tax disputes favorably more difficult. We are currently under Internal Revenue Service audit for prior tax
years, with the primary unresolved issues relating to transfer pricing. The final resolution of those audits, and other
audits or litigation, may differ from the amounts recorded in our consolidated financial statements and may materially
affect our consolidated financial statements in the period or periods in which that determination is made.

We earn a significant amount of our operating income outside the U.S. A change in the mix of earnings and losses in
countries with differing statutory tax rates, changes in our business or structure, or the expiration of or disputes about
certain tax agreements in a particular country may result in higher effective tax rates for the Company. In addition,
changes in U.S. federal and state or international tax laws applicable to corporate multinationals, other fundamental
law changes currently being considered by many countries, including in the U.S., and changes in taxing jurisdictions’
administrative interpretations, decisions, policies, and positions may materially adversely impact our consolidated
financial statements.

If our reputation or our brands are damaged, our business and operating results may be harmed . Our
reputation and brands are globally recognized and are important to our business. Our reputation and brands affect
our ability to attract and retain consumer, business, and public-sector customers. There are numerous ways our
reputation or brands could be damaged. These include product safety or quality issues, or our environmental impact
and sustainability, supply chain practices, or human rights record. We may experience backlash from customers,
government entities, advocacy groups, employees, and other stakeholders that disagree with our product offering
decisions or public policy positions. Damage to our reputation or our brands may occur from, among other things:
 The introduction of new features, products, services, or terms of service that customers, users, or partners
do not like.
 Public scrutiny of our decisions regarding user privacy, data practices, or content.
 Data security breaches, compliance failures, or actions of partners or individual employees.

The proliferation of social media may increase the likelihood, speed, and magnitude of negative brand events. If our
brands or reputation are damaged, it could negatively impact our revenues or margins, or ability to attract the most
highly qualified employees.

Our global business exposes us to operational and economic risks. Our customers are located throughout the
world and a significant part of our revenue comes from international sales. The global nature of our business creates
operational and economic risks. Our results of operations may be affected by global, regional, and local economic
developments, monetary policy, inflation, and recession, as well as political and military disputes. In addition, our
international growth strategy includes certain markets, the developing nature of which presents several risks, including
deterioration of social, political, labor, or economic conditions in a country or region, and difficulties in staffing and
managing foreign operations. Emerging nationalist trends in specific countries may significantly alter the trade
environment. Changes to trade policy or agreements as a result of populism, protectionism, or economic nationalism
may result in higher tariffs, local sourcing initiatives, or other developments that make it more difficult to sell our
products in foreign countries. Disruptions of these kinds in developed or emerging markets could negatively impact
demand for our products and services or increase operating costs. Although we hedge a portion of our international
currency exposure, significant fluctuations in foreign exchange rates between the U.S. dollar and foreign currencies
may adversely affect our results of operations.

Our business with government customers may present additional uncertainties. We derive substantial revenue
from government contracts. Government contracts generally can present risks and challenges not present in private
commercial agreements. For instance, we may be subject to government audits and investigations relating to these
contracts, we could be suspended or debarred as a governmental contractor, we could incur civil and criminal fines and
penalties, and under certain circumstances contracts may be rescinded. Some agreements may allow a government to
terminate without cause and provide for higher liability limits for certain losses.  Some contracts may be subject to

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periodic funding approval, reductions, or delays which could adversely impact public-sector demand for our products
and services. These events could negatively impact our results of operations, financial condition, and reputation.

Adverse economic or market conditions may harm our business. Worsening economic conditions, including
inflation, recession, or other changes in economic conditions, may cause lower IT spending and adversely affect our
revenue. If demand for PCs, servers, and other computing devices declines, or consumer or business spending for
those products declines, our revenue will be adversely affected.

Our product distribution system relies on an extensive partner and retail network. OEMs building devices that run our
software have also been a significant means of distribution. The impact of economic conditions on our partners, such
as the bankruptcy of a major distributor, OEM, or retailer, could cause sales channel disruption.

Challenging economic conditions also may impair the ability of our customers to pay for products and services they
have purchased. As a result, allowances for doubtful accounts and write-offs of accounts receivable may increase.

We maintain an investment portfolio of various holdings, types, and maturities. These investments are subject to
general credit, liquidity, market, and interest rate risks, which may be exacerbated by market downturns or events
that affect global financial markets. A significant part of our investment portfolio comprises U.S. government
securities. If global financial markets decline for long periods, or if there is a downgrade of the U.S. government credit
rating due to an actual or threatened default on government debt, our investment portfolio may be adversely affected
and we could determine that more of our investments have experienced an other-than-temporary decline in fair
value, requiring impairment charges that could adversely affect our consolidated financial statements.

Catastrophic events or geopolitical conditions may disrupt our business. A disruption or failure of our systems
or operations because of a major earthquake, weather event, cyberattack, terrorist attack, or other catastrophic event
could cause delays in completing sales, providing services, or performing other critical functions. Our corporate
headquarters, a significant portion of our research and development activities, and certain other essential business
operations are in the Seattle, Washington area, and we have other business operations in the Silicon Valley area of
California, both of which are seismically active regions. A catastrophic event that results in the destruction or
disruption of any of our critical business or IT systems, or the infrastructure or systems they rely on, such as power
grids, could harm our ability to conduct normal business operations. Providing our customers with more services and
solutions in the cloud puts a premium on the resilience of our systems and strength of our business continuity
management plans, and magnifies the potential impact of prolonged service outages in our consolidated financial
statements.

Abrupt political change, terrorist activity, and armed conflict pose a risk of general economic disruption in affected
countries, which may increase our operating costs. These conditions also may add uncertainty to the timing and
budget for technology investment decisions by our customers, and may cause supply chain disruptions for hardware
manufacturers. Geopolitical change may result in changing regulatory requirements that could impact our operating
strategies, access to global markets, hiring, and profitability. Geopolitical instability may lead to sanctions and impact
our ability to do business in some markets or with some public-sector customers. Any of these changes may
negatively impact our revenues.

The long-term effects of climate change on the global economy and the IT industry in particular are unclear.
Environmental regulations or changes in the supply, demand or available sources of energy or other resources may
affect the availability or cost of goods and services, including natural resources, necessary to run our business.
Changes in weather where we operate may increase the costs of powering and cooling computer hardware we use
to develop software and provide cloud-based services.

Our business depends on our ability to attract and retain talented employees. Our business is based on
successfully attracting and retaining talented employees representing diverse backgrounds, experiences, and skill
sets. The market for highly skilled workers and leaders in our industry is extremely competitive. Maintaining our
brand and reputation, as well as a diverse and inclusive work environment that enables all our employees to thrive,
are important to our ability to recruit and retain employees. We are also limited in our ability to recruit internationally
by restrictive domestic immigration laws. Changes to U.S. immigration policies that restrain the flow of technical and
professional talent may inhibit our ability to adequately staff our research and development efforts. If we are less
successful in our recruiting efforts, or if we cannot retain highly skilled workers and key leaders, our ability to develop
and deliver successful products and services may be adversely affected. Effective succession planning is also
important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving
key employees could hinder our strategic planning and execution. How employment-related laws are interpreted and

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applied to our workforce practices may result in increased operating costs and less flexibility in how we meet our
workforce needs.

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 PART II
Item 2

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

SHARE REPURCHASES AND DIVIDENDS

Following are our monthly share repurchases for the second quarter of fiscal year 2020:
 
Total Number of
Shares Purchased as Approximate Dollar Value of
Total Number Average Part of Publicly Shares that May Yet be
of Shares Price Paid Announced Plans Purchased under the Plans
Period   Purchased    Per Share    or Programs     or Programs
 
 
           (In millions)
 

October 1, 2019 – October 31, 2019     12,342,013   $ 139.25   12,342,013    $ 5,682

November 1, 2019 – November 30, 2019     
9,445,876   147.73   9,445,876    4,287
December 1, 2019 – December 31, 2019     
9,661,598   153.79   9,661,598    2,801
 
 

      31,449,487         31,449,487        

 

All share repurchases were made using cash resources. Our share repurchases may occur through open market
purchases or pursuant to a Rule 10b5-1 trading plan. The above table excludes shares repurchased to settle
employee tax withholding related to the vesting of stock awards.

Our Board of Directors declared the following dividends during the second quarter of fiscal year 2020:
Dividend
Declaration Date Record Date Payment Date Per Share Amount

(In millions)
December 4, 2019 February 20, 2020 March 12, 2020 $ 0.51 $ 3,881
 
 

We returned $8.5 billion to shareholders in the form of share repurchases and dividends in the second quarter of
fiscal year 2020. Refer to Note 14 – Stockholders’ Equity of the Notes to Financial Statements (Part I, Item 1 of this
Form 10-Q) for further discussion regarding share repurchases and dividends.

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 PART II
Item 6

ITEM 6. EXHIBITS
15.1   Letter regarding unaudited interim financial information
 
31.1   Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
31.2   Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
32.1*   Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
32.2*   Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
101.INS Inline XBRL Instance Document—the instance document does not appear in the Interactive Data File
  as its XBRL tags are embedded within the Inline XBRL document
 
101.SCH   Inline XBRL Taxonomy Extension Schema
 
101.CAL   Inline XBRL Taxonomy Extension Calculation Linkbase
 
101.DEF   Inline XBRL Taxonomy Extension Definition Linkbase
 
101.LAB   Inline XBRL Taxonomy Extension Label Linkbase
 
101.PRE   Inline XBRL Taxonomy Extension Presentation Linkbase
 
104   Cover page formatted as Inline XBRL and contained in Exhibit 101

* Furnished, not filed.

Items 3, 4, and 5 are not applicable and have been omitted.

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Item 6

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned; thereunto duly authorized.

MICROSOFT CORPORATION
 
/S/ FRANK H. BROD
Frank H. Brod
Corporate Vice President, Finance and Administration;
Chief Accounting Officer (Duly Authorized Officer)
 
January 29, 2020

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Item 6

Exhibit 15.1

Microsoft Corporation
One Microsoft Way
Redmond, WA 98052-6399

We have reviewed, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the unaudited interim financial information of Microsoft Corporation and subsidiaries for the periods ended
December 31, 2019 and 2018, and have issued our report dated January 29, 2020. As indicated in such report,
because we did not perform an audit, we expressed no opinion on that information.

We are aware that our report referred to above, which is included in your Quarterly Report on Form 10-Q for the
quarter ended December 31, 2019, is incorporated by reference in Registration Statement Nos. 333-109185, 333-
118764, 333-52852, 333-132100, 333-161516, 333-75243, 333-185757, and 333-221833 on Form S-8 and
Registration Statement Nos. 333-228062 and 333-228244 on Form S-3.

We also are aware that the aforementioned report, pursuant to Rule 436(c) under the Securities Act of 1933, is not
considered a part of the Registration Statement prepared or certified by an accountant or a report prepared or
certified by an accountant within the meaning of Sections 7 and 11 of that Act.

/s/ DELOITTE & TOUCHE LLP

Seattle, Washington
January 29, 2020
 

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Item 6

Exhibit 31.1

CERTIFICATIONS

I, Satya Nadella, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Microsoft Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly
present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be
designed under our supervision, to ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which
this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to
be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by
this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during
the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial
reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s Board of Directors
(or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and
report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in
the registrant’s internal control over financial reporting.
 

/s/ SATYA NADELLA

Satya Nadella
Chief Executive Officer

January 29, 2020

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Item 6

Exhibit 31.2

CERTIFICATIONS

I, Amy E. Hood, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Microsoft Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly
present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be
designed under our supervision, to ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which
this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to
be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by
this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during
the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial
reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s Board of Directors
(or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and
report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in
the registrant’s internal control over financial reporting.
 

/s/ AMY E. HOOD

Amy E. Hood
Executive Vice President and
Chief Financial Officer

January 29, 2020

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 PART II
Item 6

Exhibit 32.1

CERTIFICATIONS PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
(18 U.S.C. SECTION 1350)

In connection with the Quarterly Report of Microsoft Corporation, a Washington corporation (the “Company”), on
Form 10-Q for the quarter ended December 31, 2019, as filed with the Securities and Exchange Commission (the
“Report”), Satya Nadella, Chief Executive Officer of the Company, does hereby certify, pursuant to § 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350), that to his knowledge:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results
of operations of the Company.
 

/s/ SATYA NADELLA

Satya Nadella
Chief Executive Officer

January 29, 2020

[A signed original of this written statement required by Section 906 has been provided to Microsoft Corporation and
will be retained by Microsoft Corporation and furnished to the Securities and Exchange Commission or its staff upon
request.]

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 PART II
Item 6

Exhibit 32.2

CERTIFICATIONS PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
(18 U.S.C. SECTION 1350)

In connection with the Quarterly Report of Microsoft Corporation, a Washington corporation (the “Company”), on
Form 10-Q for the quarter ended December 31, 2019, as filed with the Securities and Exchange Commission (the
“Report”), Amy E. Hood, Chief Financial Officer of the Company, does hereby certify, pursuant to § 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350), that to her knowledge:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results
of operations of the Company.
 

/s/ AMY E. HOOD

Amy E. Hood
Executive Vice President and
Chief Financial Officer

January 29, 2020

[A signed original of this written statement required by Section 906 has been provided to Microsoft Corporation and
will be retained by Microsoft Corporation and furnished to the Securities and Exchange Commission or its staff upon
request.]

67