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                                 UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

 

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                                   FORM 10-K

 

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x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT 
    OF 1934                                                                      


For the Fiscal Year Ended June 30, 2013

                                       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 0-14278

 

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                             MICROSOFT CORPORATION

 

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                             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:

   COMMON STOCK, $0.00000625 par value per share                      NASDAQ

          Securities registered pursuant to Section 12(g) of the Act:

                                      NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.  Yes x  No ¨

Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes ¨  No x

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 x  No ¨

Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate Web site, if any, every Interactive Data File required
to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files).  Yes x  No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (§229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x                                                 Accelerated filer           ¨
                                                                                                      
Non-accelerated filer     ¨ (Do not check if a smaller reporting company)   Smaller reporting company   ¨


Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).  Yes ¨  No x

As of December 31, 2012, the aggregate market value of the registrant’s common
stock held by non-affiliates of the registrant was $202,945,146,270 based on the
closing sale price as reported on the NASDAQ National Market System. As of
July 18, 2013, there were 8,329,956,402 shares of common stock outstanding.

                      DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement to be delivered to shareholders in
connection with the Annual Meeting of Shareholders to be held on November 19,
2013 are incorporated by reference into Part III.

 

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                             MICROSOFT CORPORATION

                                   FORM 10-K

                    For The Fiscal Year Ended June 30, 2013

                                     INDEX

 

                                                                                       Page  
                                                                                       -----  
                                                                                     
PART I                                                                                        
                                                                                     
           Item 1.      Business                                                           3  
                                                                                     
                        Executive Officers of the Registrant                              12  
                                                                                     
           Item 1A.     Risk Factors                                                      14  
                                                                                     
           Item 1B.     Unresolved Staff Comments                                         21  
                                                                                     
           Item 2.      Properties                                                        22  
                                                                                     
           Item 3.      Legal Proceedings                                                 22  
                                                                                     
           Item 4.      Mine Safety Disclosures                                           22  
                                                                                     
PART II                                                                                       
                                                                                     
           Item 5.      Market for Registrant’s Common Equity, Related Stockholder           
                      Matters, and Issuer Purchases of Equity Securities                  22  
                                                                                     
           Item 6.      Selected Financial Data                                           23  
                                                                                     
           Item 7.      Management’s Discussion and Analysis of Financial Condition          
                      and Results of Operations                                           23  
                                                                                     
           Item 7A.     Quantitative and Qualitative Disclosures about Market Risk        47  
                                                                                     
           Item 8.      Financial Statements and Supplementary Data                       49  
                                                                                     
           Item 9.      Changes in and Disagreements with Accountants on Accounting          
                      and Financial Disclosure                                            90  
                                                                                     
           Item 9A.     Controls and Procedures                                           90  
                                                                                     
                        Report of Management on Internal Control over Financial              
                      Reporting                                                           90  
                                                                                     
                        Report of Independent Registered Public Accounting Firm           91  
                                                                                     
           Item 9B.     Other Information                                                 92  
                                                                                     
PART III                                                                                      
                                                                                     
           Item 10.     Directors, Executive Officers and Corporate Governance            92  
                                                                                     
           Item 11.     Executive Compensation                                            92  
                                                                                     
           Item 12.     Security Ownership of Certain Beneficial Owners and                  
                      Management and Related Stockholder Matters                          92  
                                                                                     
           Item 13.     Certain Relationships and Related Transactions, and Director         
                      Independence                                                        92  
                                                                                     
           Item 14.     Principal Accounting Fees and Services                            92  
                                                                                     
PART IV                                                                                       
                                                                                     
           Item 15.     Exhibits and Financial Statement Schedules                        93  
                                                                                     
                        Signatures                                                        96  


 

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                                     PART I

                                     Item 1

 

                     Note About Forward-Looking Statements

Certain statements in this report, other than purely historical information,
including estimates, projections, statements relating to our business plans,
objectives, and expected operating results, and the assumptions upon which those
statements are based, 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 without
limitation, the following sections: “Business,” “Management’s Discussion and
Analysis,” and “Risk Factors.” 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 which
may cause actual results to differ materially from the forward-looking
statements. A detailed discussion of risks and uncertainties that could cause
actual results and events to differ materially from such forward-looking
statements is included in the section titled “Risk Factors” (Part I, Item 1A of
this Form 10-K). We undertake no obligation to update or revise publicly any
forward-looking statements, whether because of new information, future events,
or otherwise.

                                     PART I

                                ITEM 1. BUSINESS

                                    GENERAL

Microsoft was founded in 1975. Our mission is to enable people and businesses
throughout the world to realize their full potential by creating technology that
transforms the way people work, play, and communicate. We develop and market
software, services, and hardware devices that deliver new opportunities, greater
convenience, and enhanced value to people’s lives. We do business worldwide and
have offices in more than 100 countries.

We generate revenue by developing, licensing, and supporting a wide range of
software products and services, by designing and selling hardware devices, and
by delivering relevant online advertising to a global customer audience. In
addition to selling individual products and services, we offer suites of
products and services.

Our products include operating systems for computing devices, servers, phones,
and other intelligent devices; server applications for distributed computing
environments; productivity applications; business solution applications; desktop
and server management tools; software development tools; video games; and online
advertising. We also design and sell hardware devices including Surface RT and
Surface Pro, the Xbox 360 gaming and entertainment console, Kinect for Xbox 360,
Xbox 360 accessories, and Microsoft PC accessories.

We offer cloud-based solutions that provide customers with software, services,
and content over the Internet by way of shared computing resources located in
centralized data centers. Examples of cloud-based computing services we offer
include Microsoft Office 365, Microsoft Dynamics CRM Online, Windows Azure,
Bing, Skype, Xbox LIVE, and Yammer. Cloud revenue is earned primarily from usage
fees, advertising, and subscriptions. We also provide consulting and product and
solution support services, and we train and certify computer system integrators
and developers.

We conduct research and develop advanced technologies for future software,
hardware, and services. We believe that we will continue to grow and meet our
customers’ needs by delivering a family of devices and services for individuals
and businesses that empower people around the globe at home, at work, and on the
go, for the activities they value most. We will continue to create new
opportunities for partners, increase customer satisfaction, and improve our
service excellence, business efficacy, and internal processes.

                               OPERATING SEGMENTS

During the periods presented, we operated our business in five segments: Windows
Division, Server and Tools, Online Services Division, Microsoft Business
Division, and Entertainment and Devices Division. Our segments

 

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provide management with a comprehensive financial view of our key businesses.
The segments enable the alignment of strategies and objectives across the
development, sales, marketing, and services organizations, and they provide a
framework for timely and rational allocation of development, sales, marketing,
and services resources within businesses. Additional information on our
operating segments and geographic and product information is contained in Note
21 – Segment Information and Geographic Data of the Notes to Financial
Statements (Part II, Item 8 of this Form 10-K). In July 2013, we announced a
change in organizational structure as part of our transformation to a devices
and services company. As we evolve how we allocate resources and analyze
performance in the new structure, it is possible that our segments may change.

Windows Division

Windows Division develops and markets operating systems for computing devices,
related software and online services, Surface RT and Pro devices, and PC
accessories. This collection of software, hardware, and services is designed to
empower individuals, companies, and organizations and to simplify everyday tasks
through seamless operations across the user’s hardware and software. Windows 8
is the first version of the Windows operating system that supports both x86 and
ARM chip architectures and that focuses on touch. With this version, Windows is
able to scale across more form factors, including mobile devices designed for
consuming information and media, and devices that have high performance
computing capabilities.

Windows Division revenue growth is impacted by growth of the computing device
market worldwide. Currently, approximately 65% of total Windows Division revenue
comes from Windows operating systems purchased by original equipment
manufacturers (“OEMs”), which they pre-install on the devices they sell.

In addition to computing device market volume, Windows revenue is impacted by:

 

     •   the proliferation of new computing devices that emphasize touch and       
         mobility functionality;                                                   


 

     •   device market changes driven by shifts between developed markets and      
         emerging markets, and consumer devices and business devices;              


 

  •   attachment of Windows to devices shipped;


 

  •   changes in inventory levels within the OEM channel;


 

     •   pricing changes and promotions, pricing variation that occurs when the mix
         of devices manufactured shifts from local and regional system builders to 
         large, multinational OEMs, and different pricing of Windows versions      
         licensed;                                                                 


 

  •   demand of commercial customers for volume licensing and software assurance;


 

  •   sales of packaged software; and


 

  •   sales of Surface RT and Pro devices.


Principal Products and Services:  Windows operating system; Windows Services
suite of applications and web services, including Outlook.com and SkyDrive;
Surface RT and Pro devices; and PC accessories.

The general availability of Surface RT and Windows 8 started on October 26,
2012. The general availability of Surface Pro started on February 9, 2013. A
preview of Windows 8.1 was released on June 26, 2013.

Competition

The Windows operating system faces competition from various commercial software
products and from alternative platforms and devices, mainly from Apple and
Google. We believe Windows competes effectively by giving customers choice,
value, flexibility, security, an easy-to-use interface, compatibility with a
broad range of hardware and software applications, including those that enable
productivity, and the largest support network for any operating system. The
Windows 8 operating system includes the Windows Store, an online application
marketplace. This marketplace benefits our developer and partner ecosystems by
providing access to a large customer base and benefits Windows users by
providing centralized access to certified applications.

 

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Windows Services software and applications, including SkyDrive and Outlook.com,
compete with similar software and service products from Apple, Google, Yahoo!,
and a wide array of websites and portals that provide communication and sharing
tools and services.

Surface Pro and RT devices and our PC accessories face competition from
computer, tablet, and other hardware manufacturers, many of which are also
current or potential partners and customers.

Server and Tools

Server and Tools develops and markets server software, software developer tools,
cloud-based services, and solutions that are designed to make information
technology professionals and developers and their systems more productive and
efficient. We offer our customers both on-premise software and cloud-based
offerings, bringing together the benefits of traditional on-site offerings with
cloud-based services. Server software is integrated server infrastructure and
middleware designed to support software applications built on the Windows Server
operating system. This includes the server platform, database, business
intelligence, storage, management and operations, virtualization,
service-oriented architecture platform, security and identity software. Server
and Tools also builds standalone and software development lifecycle tools for
software architects, developers, testers, and project managers. Server offerings
can be run on-site, in a partner-hosted environment, or in a Microsoft-hosted
environment.

Our cloud-based services comprise a scalable operating system with computing,
storage, database, and management, along with comprehensive cloud solutions,
from which customers can build, deploy, and manage enterprise workloads and web
applications. These services also include a platform that helps developers build
and connect applications and services in the cloud or on premise. Our goal is to
enable customers to devote more resources to development and use of applications
that benefit their businesses, rather than managing on-premises hardware and
software.

Windows Embedded extends the power of Windows and the cloud to intelligent
systems by delivering specialized operating systems, tools, and services. In
addition, Server and Tools offers a broad range of enterprise consulting and
product support services (“Enterprise Services”) that assist customers in
developing, deploying, and managing Microsoft server and desktop solutions.
Server and Tools also provides training and certification to developers and
information technology professionals for our Server and Tools, Microsoft
Business Division, and Windows Division products and services.

Approximately 80% of Server and Tools revenue comes from product revenue,
including purchases through volume licensing programs, licenses sold to OEMs,
and retail packaged product, while the remainder comes from Enterprise Services.

Principal Products and Services:  Windows Server operating systems; Windows
Azure; Microsoft SQL Server; Windows Intune; Windows Embedded; Visual Studio;
System Center products; Microsoft Consulting Services; and Premier product
support services.

Competition

Our server operating system products face competition from a wide variety of
server operating systems and applications offered by companies with a range of
market approaches. Vertically integrated computer manufacturers such as
Hewlett-Packard, IBM, and Oracle offer their own versions of the Unix operating
system preinstalled on server hardware. Nearly all computer manufacturers offer
server hardware for the Linux operating system and many contribute to Linux
operating system development. The competitive position of Linux has also
benefited from the large number of compatible applications now produced by many
commercial and non-commercial software developers. A number of companies, such
as Red Hat, supply versions of Linux.

We compete to provide enterprise-wide computing solutions and point solutions
with numerous commercial software vendors that offer solutions and middleware
technology platforms, software applications for connectivity (both

 

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Internet and intranet), security, hosting, database, and e-business servers. IBM
and Oracle lead a group of companies focused on the Java Platform Enterprise
Edition that compete with our enterprise-wide computing solutions. Commercial
competitors for our server applications for PC-based distributed client/server
environments include CA Technologies, IBM, and Oracle. Our Web application
platform software competes with open source software such as Apache, Linux,
MySQL, and PHP. In middleware, we compete against Java middleware such as
Geronimo, JBoss, and Spring Framework.

Our system management solutions compete with server management and server
virtualization platform providers, such as BMC, CA Technologies,
Hewlett-Packard, IBM, and VMware. Our database, business intelligence, and data
warehousing solutions offerings compete with products from IBM, Oracle, SAP, and
other companies. Our products for software developers compete against offerings
from Adobe, IBM, Oracle, other companies, and open-source projects, including
Eclipse (sponsored by CA Technologies, IBM, Oracle, and SAP), PHP, and Ruby on
Rails, among others.

Our embedded systems compete in a highly fragmented environment in which key
competitors include IBM, Intel, and versions of embeddable Linux from commercial
Linux vendors such as Metrowerks and MontaVista Software.

Our cloud-based services face diverse competition from companies such as Amazon,
Google, IBM, Oracle, Salesforce.com, VMware, and other open source offerings.
The Enterprise Services business competes with a wide range of companies,
including multinational consulting firms and small niche businesses focused on
specific technologies.

We believe our server products, cloud-based services, and Enterprise Services
provide customers with advantages in performance, total costs of ownership, and
productivity by delivering superior applications, development tools,
compatibility with a broad base of hardware and software applications, security,
and manageability.

Online Services Division

Online Services Division (“OSD”) develops and markets information and content
designed to help people simplify tasks and make more informed decisions online,
and help advertisers connect with audiences. OSD offerings include Bing, Bing
Ads, and MSN. We are also the exclusive algorithmic and paid search platform for
Yahoo! websites worldwide. We have completed the Yahoo! worldwide algorithmic
transition and the paid search transition in the U.S. and several international
markets, and are transitioning paid search in the remaining international
markets. Bing and MSN generate revenue through the sale of search and display
advertising, accounting for nearly all of OSD’s revenue. We have expanded Bing
beyond a standalone consumer search engine, and have integrated the technology
into other Microsoft products, including Windows 8, the new Office, Xbox 360,
and Windows Phone, to enhance those offerings. We plan to continue to
incorporate Bing into our product and service portfolio.

Principal Products and Services:  Bing; Bing Ads; and MSN.

Competition

OSD competes with Google and a wide array of websites and portals that provide
content and online offerings to end users. Our success depends on our ability to
attract new users, understand intent, and match intent with relevant content and
advertiser offerings. We believe we can attract new users by continuing to offer
new and compelling products and services and to further differentiate our
offerings by providing a broad selection of content and by helping users make
faster, more informed decisions and take action more quickly by providing
relevant search results, expanded search services, and deeply-integrated social
recommendations.

Microsoft Business Division

Microsoft Business Division (“MBD”) offerings consist of the Microsoft Office
system (“Office,” comprising mainly the core Office product set, Office 365,
SharePoint, Exchange, and Lync) and Microsoft Dynamics business solutions, which
may be delivered either on premise or as a cloud-based service. Office is
designed to increase personal,

 

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team, and organization productivity through a range of programs, services, and
software solutions and generates over 90% of MBD revenue. Growth in Office
depends on our ability to add value to the core Office product set and to
continue to expand our product offerings in other areas such as content
management, enterprise search, collaboration, unified communications, and
business intelligence. Microsoft Dynamics products provide business solutions
for financial management, customer relationship management (“CRM”), supply chain
management, and analytics applications for small and mid-size businesses, large
organizations, and divisions of global enterprises.

Approximately 85% of MBD revenue is generated from sales to businesses, which
includes Office revenue generated through subscriptions and volume licensing
agreements as well as Microsoft Dynamics revenue. Revenue from sales to
businesses generally depends upon the number of information workers in a
licensed enterprise and is therefore relatively independent of the number of PCs
sold in a given year. Approximately 15% of MBD revenue is derived from sales to
consumers, which includes revenue from retail packaged product, subscription
sales, and OEM revenue. This revenue generally is affected by the level of PC
shipments, the shift to subscription-based licensing, and product launches.

Principal Products and Services:  Microsoft Office; Microsoft Exchange;
Microsoft SharePoint; Microsoft Lync; Yammer; Microsoft Office Project and
Office Visio; Microsoft Dynamics ERP and Dynamics CRM; Microsoft Office 365,
which is an online services offering of Microsoft Office, Exchange, SharePoint,
Lync, and Microsoft Office Web Apps, which are the online companions to
Microsoft Word, Excel, PowerPoint, and OneNote.

The general availability of the new Office started on January 29, 2013.

Competition

Competitors to Office include software application vendors such as Adobe, Apple,
Cisco, Google, IBM, Oracle, SAP, and numerous Web-based competitors as well as
local application developers in Asia and Europe. Apple distributes versions of
its application software products with various models of its PCs and through its
mobile devices and has a measurable installed base for these pre-installed
applications, such as email, note taking, and calendar. Cisco is using its
position in enterprise communications equipment to grow its unified
communications business. IBM has a measurable installed base with its office
productivity products. Google provides a hosted messaging and productivity suite
that competes with Office. Web-based offerings competing with individual
applications can also position themselves as alternatives to Office products. We
believe our products compete effectively based on our strategy of providing
powerful, flexible, secure, easy to use solutions that work well with
technologies our customers already have and are available on a device or via the
cloud.

Our Microsoft Dynamics products compete with vendors such as Oracle and SAP in
the market for large organizations and divisions of global enterprises. In the
market focused on providing solutions for small and mid-sized businesses, our
Microsoft Dynamics products compete with vendors such as Infor, Sage, and
NetSuite. Salesforce.com’s on-demand CRM offerings compete directly with
Microsoft Dynamics CRM Online and Microsoft Dynamics CRM’s on-premise offerings.

Entertainment and Devices Division

Entertainment and Devices Division (“EDD”) develops and markets products and
services designed to entertain and connect people. The Xbox entertainment
platform, including Kinect, is designed to provide a unique variety of
entertainment choices through the use of our devices, peripherals, content, and
online services. Skype is designed to connect friends, family, clients, and
colleagues through a variety of devices. Windows Phone is designed to bring
users closer to the people, applications, and content they need, while providing
unique capabilities such as Microsoft Office and Xbox LIVE. Through a strategic
alliance, Windows Phone and Nokia are jointly creating new mobile products and
services and extending established product and services to new markets. EDD
revenue also includes revenue from licensing mobile-related patents.

Principal Products and Services:  Xbox 360 gaming and entertainment console,
Kinect for Xbox 360, Xbox 360 video games, Xbox 360 accessories; Xbox LIVE;
Skype; and Windows Phone.

 

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Competition

Our Xbox gaming and entertainment business competes with console platforms from
Nintendo and Sony, both of which have a large, established base of customers.
The lifecycle for gaming and entertainment consoles averages five to 10 years.
We released Xbox 360 in November 2005. Nintendo and Sony released competing
versions of their game consoles in November 2006. In June 2013, we announced
that we expect our next generation console, Xbox One, to be available for
purchase in the second quarter of fiscal year 2014. Sony also announced their
next generation console will be available for purchase in late 2013. Nintendo
released their latest generation console in November 2012.

We believe the success of gaming and entertainment consoles is determined by the
availability of games for the console, providing exclusive game content that
gamers seek, the computational power and reliability of the console, and the
ability to create new experiences via online services, downloadable content, and
peripherals. In addition to Nintendo and Sony, our businesses compete with both
Apple and Google in offering content products and services to the consumer. We
believe the Xbox entertainment platform is positioned well against competitive
products and services based on significant innovation in hardware architecture,
user interface, developer tools, online gaming and entertainment services, and
continued strong exclusive content from our own game franchises as well as other
digital content offerings.

Windows Phone faces competition primarily from Apple, Google, and Blackberry.
Skype competes primarily with Apple and Google, which offer a selection of
instant messaging, voice, and video communication products.

We compete primarily on the basis of product quality and variety, unique
capabilities of our products, timing of product releases, and effectiveness of
distribution and marketing.

                                   OPERATIONS

We have operations centers that support all operations in their regions,
including customer contract and order processing, credit and collections,
information processing, and vendor management and logistics. The regional center
in Ireland supports the European, Middle Eastern, and African region; the center
in Singapore supports the Japan, India, Greater China, and Asia-Pacific region;
and the centers in Fargo, North Dakota, Fort Lauderdale, Florida, Puerto Rico,
Redmond, Washington, and Reno, Nevada support Latin America and North America.
In addition to the operations centers, we also operate data centers throughout
the Americas, Europe, and Asia regions.

To serve the needs of customers around the world and to improve the quality and
usability of products in international markets, we localize many of our products
to reflect local languages and conventions. Localizing a product may require
modifying the user interface, altering dialog boxes, and translating text.

We contract most of our manufacturing activities for Xbox 360 and related games,
Kinect for Xbox 360, various retail software packaged products, Surface devices,
and Microsoft PC accessories to third parties. Our products may include some
components that are available from only one or limited sources. Our Xbox 360
console, Kinect for Xbox 360, Surface devices, and Microsoft PC accessories
include key components that are supplied by a single source. The integrated
central processing unit/graphics processing unit for the Xbox 360 console is
purchased from IBM, and the supporting embedded dynamic random access memory
chips are purchased from Taiwan Semiconductor Manufacturing Company. We
generally have the ability to use other manufacturers if the current vendor
becomes unavailable or unable to meet our requirements. We generally have
multiple sources for raw materials, supplies, and components, and are often able
to acquire component parts and materials on a volume discount basis.

                            RESEARCH AND DEVELOPMENT

During fiscal years 2013, 2012, and 2011, research and development expense was
$10.4 billion, $9.8 billion, and $9.0 billion, respectively. These amounts
represented 13% of revenue in each of those years. We plan to continue to make
significant investments in a broad range of research and development efforts.

 

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Product and Service Development and Intellectual Property

We develop most of our products and services internally. Internal development
allows us to maintain competitive advantages that come from product
differentiation and closer technical control over our products and services. It
also gives us the freedom to decide which modifications and enhancements are
most important and when they should be implemented. We strive to obtain
information as early as possible about changing usage patterns and hardware
advances that may affect software design. Before releasing new software
platforms, we provide application vendors with a range of resources and
guidelines for development, training, and testing. Generally, we also create
product documentation internally.

We protect our intellectual property investments in a variety of ways. We work
actively in the U.S. and internationally to ensure the enforcement of copyright,
trademark, trade secret, and other protections that apply to our software and
hardware products, services, business plans, and branding. We are a leader among
technology companies in pursuing patents and currently have a portfolio of over
35,000 U.S. and international patents issued and over 38,000 pending. While we
employ much of our internally developed intellectual property exclusively in
Microsoft products and services, we also engage in outbound and inbound
licensing of specific patented technologies that are incorporated into
licensees’ or Microsoft’s products. From time to time, we enter into broader
cross-license agreements with other technology companies covering entire groups
of patents. We also purchase or license technology that we incorporate into our
products or services. At times, we make select intellectual property broadly
available at no or low cost to achieve a strategic objective, such as promoting
industry standards, advancing interoperability, or attracting and enabling our
external development community.

While it may be necessary in the future to seek or renew licenses relating to
various aspects of our products and business methods, we believe, based upon
past experience and industry practice, such licenses generally could be obtained
on commercially reasonable terms. We believe our continuing research and product
development are not materially dependent on any single license or other
agreement with a third party relating to the development of our products.

Investing in the Future

Microsoft’s success is based on our ability to create new and compelling
products, services, and experiences for our users, to initiate and embrace
disruptive technology trends, to enter new geographic and product markets, and
to drive broad adoption of our products and services. We invest in a range of
emerging technology trends and breakthroughs that we believe offer significant
opportunities to deliver value to our customers and growth for the company. We
maintain our long-term commitment to research and development across a wide
spectrum of technologies, tools, and platforms spanning communication and
collaboration, information access and organization, entertainment, business and
e-commerce, advertising, and devices.

While our main research and development facilities are located in Redmond,
Washington, we also operate research and development facilities in other parts
of the U.S. and around the world, including Canada, China, Denmark, Estonia,
Germany, India, Ireland, Israel, and the United Kingdom. This global approach
helps us remain competitive in local markets and enables us to continue to
attract top talent from across the world. We generally fund research at the
corporate level to ensure that we are looking beyond immediate product
considerations to opportunities further in the future. We also fund research and
development activities at the business segment level. Much of our business
segment level research and development is coordinated with other segments and
leveraged across the company.

In addition to our main research and development operations, we also operate
Microsoft Research. Microsoft Research is one of the world’s largest computer
science research organizations, and works in close collaboration with top
universities around the world to advance the state-of-the-art in computer
science, providing us a unique perspective on future technology trends.

Based on our assessment of key technology trends and our broad focus on
long-term research and development, we see significant opportunities to drive
future growth in smart connected devices, cloud computing, entertainment,
search, communications, and productivity through our devices and services
strategy.

 

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                       DISTRIBUTION, SALES, AND MARKETING

We market and distribute our products and services primarily through the
following channels: OEMs; distributors and resellers; and online.

OEMs

We distribute software through OEMs that pre-install our software on new PCs,
tablets, servers, smartphones, and other intelligent devices that they sell to
end customers. The largest component of the OEM business is the Windows
operating system pre-installed on computing devices. OEMs also sell hardware
pre-installed with other Microsoft products, including server and embedded
operating systems and applications such as our Microsoft Office suite. In
addition to these products, we also market our services, such as our Windows
SkyDrive service, through OEMs.

There are two broad categories of OEMs. The largest OEMs, many of which operate
globally, are referred to as “Direct OEMs,” as our relationship with them is
managed through a direct agreement between Microsoft and the OEM. We have
distribution agreements covering one or more of our products with virtually all
of the multinational OEMs, including Acer, ASUS, Dell, Fujitsu, HTC,
Hewlett-Packard, LG, Lenovo, Nokia, Samsung, Sony, Toshiba, and with many
regional and local OEMs. The second broad category of OEMs consists of
lower-volume PC manufacturers (also called “system builders”), which source
their Microsoft software for pre-installation and local redistribution primarily
through the Microsoft distributor channel rather than through a direct agreement
or relationship with Microsoft.

Distributors and Resellers

Many organizations that license our products and services through enterprise
agreements transact directly with us, with sales support from solution
integrators, independent software vendors, web agencies, and developers that
advise organizations on licensing our products and services (“Enterprise
Software Advisors”). Organizations also license our products and services
indirectly, primarily through large account resellers (“LARs”), distributors,
value-added resellers (“VARs”), OEMs, system builder channels, and retailers.
Although each type of reselling partner reaches organizations of all sizes, LARs
are primarily engaged with large organizations, distributors resell primarily to
VARs, and VARs typically reach small-sized and medium-sized organizations.
Enterprise Software Advisors typically are also authorized as LARs and operate
as resellers for our other licensing programs, such as the Select Plus and Open
licensing programs discussed under “Licensing Options” below. Some of our
distributors include Ingram Micro and Tech Data, and some of our largest
resellers include CDW, Dell, Insight Enterprises, and Software House
International.

Our Microsoft Dynamics software offerings are licensed to enterprises through a
global network of channel partners providing vertical solutions and specialized
services. We distribute our retail packaged products primarily through
independent non-exclusive distributors, authorized replicators, resellers, and
retail outlets. Individual consumers obtain these products primarily through
retail outlets, such as Wal-Mart, Dixons, and Microsoft Stores. We distribute
our hardware products, including Surface, Xbox, and PC accessories, through
third-party retailers and Microsoft Stores. We have a network of field sales
representatives and field support personnel that solicits orders from
distributors and resellers, and provides product training and sales support.

Online

Although client-based software will continue to be an important part of our
business, increasingly we are delivering additional value to customers through
cloud-based services. We provide online content and services to consumers
through Bing, MSN portals and channels, Microsoft Office Web Apps, Office 365,
Windows Phone Marketplace, Xbox LIVE, Outlook.com, Skype, and Windows Store. We
also provide to business users commercial cloud-based services such as Exchange
Online, Microsoft Dynamics CRM Online, Windows Azure, Windows Intune, and Office
365 consisting of online versions of Office, Exchange, SharePoint, Lync, and
Yammer. Other services delivered

 

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online include our online advertising platform with offerings for advertisers
and publishers, as well as Microsoft Developer Networks subscription content and
updates, periodic product updates, and online technical and practice readiness
resources to support our partners in developing and selling our products and
solutions. As we increasingly deliver online services, we sell many of these
cloud-based services through our enterprise agreements and have also enabled new
sales programs to reach small and medium-sized businesses. These new programs
include direct sales, direct sales supported by a large network of partner
advisors, and resales of services through operator channels, such as telephone,
cell, and cable providers. We also sell our products through our online store,
microsoftstore.com.

                               LICENSING OPTIONS

We license software to organizations under arrangements that allow the end-user
customer to acquire multiple licenses of products and services. Our arrangements
for organizations to acquire multiple licenses of products and services are
designed to provide them with a means of doing so without having to acquire
separate packaged product through retail channels. In delivering organizational
licensing arrangements to the market, we use different programs designed to
provide flexibility for organizations of various sizes. While these programs may
differ in various parts of the world, generally they include those discussed
below.

Open Licensing

Designed primarily for small-to-medium organizations, Open Programs allows
customers to acquire perpetual or subscription licenses and, at the customer’s
election, rights to future versions of software products over a specified time
period (two or three years depending on the Open Programs used). The offering
that conveys rights to future versions of certain software products over the
contract period is called software assurance. Software assurance also provides
support, tools, and training to help customers deploy and use software
efficiently. Open Programs has several variations to fit customers’ diverse way
of purchasing. Under the Open License Program, customers can acquire licenses
only or licenses with software assurance. They can also renew software assurance
upon the expiration of existing volume licensing agreements.

Select Plus Licensing

Designed primarily for medium-to-large organizations, the Select Plus Program
allows customers to acquire perpetual licenses and, at the customer’s election,
software assurance over a specified time period (generally three years or less).
Similar to Open Programs, the Select Plus Program allows customers to acquire
licenses only, acquire licenses with software assurance, or renew software
assurance upon the expiration of existing volume licensing agreements. Online
services are also available for purchase through the Select Plus Program, and
subscriptions are generally structured with terms between one and three years.

Partner Licensing

The Microsoft Services Provider License Agreement is a program targeted at
service providers and Independent Software Vendors allowing these partners to
provide software services and hosted applications to their end customers.
Agreements are generally structured with a three-year term, and partners are
billed monthly based upon consumption. Microsoft Online Services Reseller
Agreement is a program enabling partners to package Microsoft Online Services
with the partners’ services. Microsoft Online Subscription Agreement is designed
to enable small and medium-sized businesses to easily purchase Microsoft Online
Services. The program allows customers to acquire monthly or annual
subscriptions for cloud-based services. Windows Azure Agreement is designed to
enable small and medium-sized businesses to purchase Windows Azure Subscription
plans on a “pay-as-you-go” basis.

Enterprise Agreement Licensing

Enterprise agreements are targeted at medium- and large-sized organizations that
want to acquire licenses to Online Services and/or software products, along with
software assurance, for all or substantial parts of their enterprise.

 

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Enterprises can elect to either acquire perpetual licenses or, under the
Enterprise Subscription Program, can acquire non-perpetual, subscription
agreements for a specified time period (generally three years). Online Services
are also available for purchase through the enterprise agreement and
subscriptions are generally structured with three year terms.

                                   CUSTOMERS

Our customers include individual consumers, small- and medium-sized
organizations, enterprises, governmental institutions, educational institutions,
Internet service providers, application developers, and OEMs. Consumers and
small and medium-sized organizations obtain our products primarily through
distributors, resellers, and OEMs. No sales to an individual customer accounted
for more than 10% of fiscal year 2013, 2012, or 2011 revenue. Our practice is to
ship our products promptly upon receipt of purchase orders from customers;
consequently, backlog is not significant.

                      EXECUTIVE OFFICERS OF THE REGISTRANT

Our executive officers as of July 30, 2013 were as follows:

 

Name                 Age     Position with the Company                                     
-------------------------------------------------------------------------------------------
                           
Steven A. Ballmer     57     Chief Executive Officer                                       
Anthony J. Bates      46     Executive Vice President, Business Development and Evangelism 
Lisa E. Brummel       53     Executive Vice President, Human Resources                     
Amy E. Hood           41     Executive Vice President, Chief Financial Officer             
Tami Reller           49     Executive Vice President, Marketing                           
Eric D. Rudder        46     Executive Vice President, Advanced Strategy and Research      
Bradford L. Smith     54     Executive Vice President, General Counsel; Secretary          
B. Kevin Turner       48     Chief Operating Officer                                       


--------------------------------------------------------------------------------
Mr. Ballmer was appointed Chief Executive Officer in January 2000. He served as
President from 1998 to 2001. Previously, he had served as Executive Vice
President, Sales and Support since 1992. Mr. Ballmer joined Microsoft in 1980.

Mr. Bates was named Executive Vice President, Business Development and
Evangelism in July 2013. He had been President of Microsoft’s Skype Division
since its acquisition by Microsoft in 2011. Mr. Bates had been Chief Executive
Officer of Skype since 2010. Before joining Skype, Mr. Bates spent nearly 15
years at Cisco Systems, Inc. where he had been Senior Vice President and General
Manager of several business groups, including Enterprise, Commercial and Small
Business, and Cisco’s core high-end router business.

Ms. Brummel, Executive Vice President, Human Resources, has served as
Microsoft’s senior human resources executive since 2005. From 2000 to 2005, she
had been Corporate Vice President of the Home and Retail Division. Since joining
Microsoft in 1989, Ms. Brummel has held a number of management positions at
Microsoft, including General Manager of Consumer Productivity Business, Product
Unit Manager of the Kids Business, and Product Unit Manager of Desktop and
Decision Reference Products.

Ms. Hood, Executive Vice President, Chief Financial Officer, was appointed Chief
Financial Officer in May 2013. Beginning in 2010, Ms. Hood was Chief Financial
Officer of the Microsoft Business Division. From 2006 through 2009, Ms. Hood was
General Manager, Microsoft Business Division Strategy. Since joining Microsoft
in 2002, Ms. Hood has also held finance-related positions in the Server and
Tools Business and the corporate finance organization.

Ms. Reller was named Executive Vice President, Marketing in July 2013. From 2011
to 2013 Ms. Reller was Chief Marketing Officer and Chief Financial Officer for
Windows. Ms. Reller served as Corporate Vice President, Windows Division
Marketing and Finance from 2009 to 2011 and as Corporate Vice President,
Business Solutions beginning in 2002. Ms. Reller joined Microsoft with its
acquisition of Great Plains Software, where she was Chief Financial Officer, in
2001.

 

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Mr. Rudder was named Executive Vice President, Advanced Strategy and Research in
July 2013. Mr. Rudder had been Chief Technical Strategy Officer since 2005.
Since joining Microsoft in 1988, Mr. Rudder held several positions in networking
and operating systems and developer tools, and was Senior Vice President, Server
and Tools from 2003 to 2005 and Senior Vice President, Developer and Platform
Evangelism from 2001 to 2003.

Mr. Smith, Executive Vice President, General Counsel, and Secretary, has served
in that role since November 2001. Mr. Smith was also named Chief Compliance
Officer in 2002. He had been Deputy General Counsel for Worldwide Sales and
previously was responsible for managing the European Law and Corporate Affairs
Group, based in Paris. Mr. Smith joined Microsoft in 1993.

Mr. Turner was named Chief Operating Officer in September 2005. Before joining
Microsoft, he was Executive Vice President of Wal-Mart Stores, Inc. and
President and Chief Executive Officer of the Sam’s Club division. From 2001 to
2002, he served as Executive Vice President and Chief Information Officer of
Wal-Mart’s Information Systems Division. From 2000 to 2001, he served as its
Senior Vice President and Chief Information Officer of the Information Systems
Division. Mr. Turner also serves on the Board of Directors of Nordstrom, Inc.

                                   EMPLOYEES

As of June 30, 2013, we employed approximately 99,000 people on a full-time
basis, 58,000 in the U.S. and 41,000 internationally. Of the total, 37,000 were
in product research and development, 26,000 in sales and marketing, 21,000 in
product support and consulting services, 6,000 in manufacturing and
distribution, and 9,000 in general and administration. Our success is highly
dependent on our ability to attract and retain qualified employees. None of our
employees are subject to collective bargaining agreements.

                             AVAILABLE INFORMATION

Our Internet address is www.microsoft.com. At our Investor Relations website,
www.microsoft.com/investor, we make available free of charge a variety of
information for investors. Our goal is to maintain the Investor Relations
website as a portal through which investors can easily find or navigate to
pertinent information about us, including:

 

     •   our annual report on Form 10-K, quarterly reports on Form 10-Q, current   
         reports on Form 8-K, and any amendments to those reports, as soon as      
         reasonably practicable after we electronically file that material with or 
         furnish it to the Securities and Exchange Commission (“SEC”);             


 

     •   information on our business strategies, financial results, and key        
         performance indicators;                                                   


 

     •   announcements of investor conferences, speeches, and events at which our  
         executives talk about our product, service, and competitive strategies.   
         Archives of these events are also available;                              


 

     •   press releases on quarterly earnings, product and service announcements,  
         legal developments, and international news;                               


 

     •   corporate governance information including our articles, bylaws,          
         governance guidelines, committee charters, codes of conduct and ethics,   
         global corporate citizenship initiatives, and other governance-related    
         policies;                                                                 


 

     •   other news and announcements that we may post from time to time that      
         investors might find useful or interesting; and                           


 

     •   opportunities to sign up for email alerts and RSS feeds to have           
         information pushed in real time.                                          


The information found on our website is not part of this or any other report we
file with, or furnish to, the SEC.

 

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                             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 our businesses generally are low
and software products can be distributed broadly and quickly at relatively low
cost. 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 platforms, ecosystems, and devices

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. The strategic importance of developing and
maintaining a vibrant ecosystem increased with the launch of the Windows 8
operating system, Surface, Windows Phone, and associated cloud-based services.
We face significant competition from firms that provide competing platforms,
applications, and services.

 

     •   A competing vertically-integrated model, in which a single firm controls  
         the software and hardware elements of a product and related services, has 
         been successful with some consumer products such as personal computers,   
         tablets, mobile phones, gaming consoles, and digital music players.       
         Competitors pursuing this model also earn revenue from services that are  
         integrated with the hardware and software platform. We also offer some    
         vertically-integrated hardware and software products and services;        
         however, our competitors in smartphones and tablets have established      
         significantly larger user bases. Efforts to compete with the vertically   
         integrated model will increase our cost of revenue and reduce our         
         operating margins.                                                        


 

     •   We derive substantial revenue from licenses of Windows operating systems  
         on personal computers. We face substantial competitive challenges 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 
         would have been performed by personal computers in the past. 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         
         applications developers to our platforms. In addition, Surface competes   
         with products made by our OEM partners, which may affect their commitment 
         to our platform.                                                          


 

     •   Competing platforms have applications marketplaces (sometimes referred to 
         as “stores”) with scale and significant installed bases on mobile devices.
         These applications leverage free and user-paid services that over time    
         result in disincentives for users to switch to competing platforms. In    
         order to compete, we must successfully enlist developers to write         
         applications for our marketplace and ensure that these applications have  
         high quality, customer appeal, and value. Efforts to compete with these   
         application marketplaces may increase our cost of revenue and lower our   
         operating margins.                                                        


 

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Business model competition

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

 

     •   Under the license-based proprietary software model that generates most of 
         our 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 and we expect this competition to continue.              


 

     •   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 using an open source business model by     
         modifying and then distributing open source software at nominal cost to   
         end-users and earning revenue on advertising or complementary services and
         products. These firms do not bear the full costs of research and          
         development for the software. Some open source software vendors develop   
         software that mimics the features and functionality of our products.      


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

Our increasing focus on services presents execution and competitive risks.  A
growing part of our strategy involves cloud-based services used with smart
devices. 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 in some cases the user’s choice of which suite of cloud-based services
to use. We are devoting significant resources to develop and deploy our own
competing cloud-based strategies. The Windows ecosystem must continue to evolve
with this changing environment. While we believe our expertise, investments in
infrastructure, and the breadth of our cloud-based services provide us with a
strong foundation to compete, it is uncertain whether our strategies will
attract the users or generate the revenue required to be successful. In addition
to software development costs, we are incurring costs to build and maintain
infrastructure to support cloud computing services. These costs may reduce the
operating margins we have previously achieved. Whether we are successful in this
new business model depends on our execution in a number of 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, and television-related devices;                     


 

     •   continuing to enhance the attractiveness of our cloud platforms to        
         third-party developers; and                                               


 

     •   ensuring that our cloud-based services meet the reliability expectations  
         of our customers and maintain the security of their data.                 


In July 2013, we announced a change in organizational structure as part of our
transformation to a devices and services company. This change in structure is
designed to enable us to innovate with greater speed, efficiency, and capability
in the fast-changing competitive environment. We expect this change to alter the
way we plan, develop, and market our products and services, as we pursue a
single strategy to offer a family of devices and services designed to empower
our customers for the activities they value most. It is uncertain whether our
“One Microsoft” strategy will yield the anticipated efficiencies or competitive
benefits.

As we increasingly license cloud-based versions of our products and services,
such as Office 365, 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 period of the subscription.

 

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We make significant investments in new products and services that may not be
profitable.  We will continue to make significant investments in research,
development, and marketing for existing products, services, and technologies,
including the Windows operating system, the Microsoft Office system, Bing,
Windows Phone, Windows Server, the Windows Store, the Windows Azure Services
platform, Office 365, other cloud-based services offerings, and the Xbox 360
entertainment platform. We will continue to invest in new software and hardware
products, services, and technologies, such as the Microsoft-designed and
manufactured Surface launched in October 2012. 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
products or upgrades, unfavorably impacting revenue. We may not achieve
significant revenue from new product, service, and distribution channel
investments for a number of years, if at all. Moreover, 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.

In October 2012, we launched Windows 8, a major new release of our operating
system, which seeks to deliver a unique user experience through well-integrated
software, hardware, and services. Its success depends on a number of factors
including the extent to which customers embrace the new user interface and
functionality, successfully coordinating with our OEM partners in releasing a
variety of hardware devices that take advantage of new features, pricing Windows
8-based devices competitively, and attracting developers at scale to ensure a
competitive array of quality applications. The marketing costs we are incurring
to promote Windows 8 and associated services and devices may reduce our
operating margins.

Acquisitions, joint ventures, and strategic alliances may have an adverse effect
on our business.  We expect to continue making acquisitions or entering into
joint ventures and strategic alliances as part of our long-term business
strategy. These transactions involve significant challenges and risks including
that the transaction does not advance our business strategy, that we do not
realize a satisfactory return on our investment, that we experience difficulty
integrating new employees, business systems, and technology, or that the
transaction diverts management’s attention from our other businesses. Our
acquisition of Skype, for example, provides opportunities to enhance our
existing products. The success of this acquisition will depend in part on our
ability to provide compelling experiences that distinguish us from our
competitors in both consumer and business markets. It may take longer than
expected to realize the full benefits from these transactions, such as increased
revenue, enhanced efficiencies, or increased market share, or the benefits may
ultimately be smaller than anticipated or may not be realized. These events
could harm our operating results or financial condition.

We may not be able to adequately protect our intellectual property
rights.  Protecting our global intellectual property rights and combating
unlicensed copying and use of our software and other intellectual property is
difficult. While piracy adversely affects U.S. revenue, the impact on revenue
from outside the U.S. is more significant, particularly in countries where laws
are less protective of intellectual property rights. As a result, our revenue in
these markets may grow slower than the underlying PC market. Similarly, the
absence of harmonized patent laws makes it more difficult to ensure consistent
respect for patent rights. Throughout the world, we actively educate consumers
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. However, continued educational and enforcement efforts may fail to
enhance revenue. Reductions in the legal protection for software intellectual
property rights could adversely affect revenue.

Third parties may claim we infringe their intellectual property rights.  From
time to time, we receive notices from others claiming we infringe their
intellectual property rights. The number of these claims may grow because of
constant technological change in the segments in which we compete, the extensive
patent coverage of existing technologies, the rapid rate of issuance of new
patents, and our offering of Microsoft-branded services and hardware devices,
such as 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. In addition to 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

 

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as Germany, an injunction can be issued before the parties have fully litigated
the validity of the underlying patents. We have made and expect to continue
making significant expenditures 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.

We may not be able to protect our source code from copying if there is an
unauthorized disclosure of source code.  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 a number of licensees, we take significant measures to
protect the secrecy of large portions of our source code. If an unauthorized
disclosure of a significant portion of our source code occurs, we could
potentially lose future trade secret protection for that source code. It may
become easier for third parties to compete with our 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 in the next paragraph.

Cyber-attacks and security vulnerabilities could lead to reduced revenue,
increased costs, liability claims, or harm to our competitive position.

Security of Microsoft’s information technology

Maintaining the security of computers and computer networks is paramount for us
and our customers. Threats to information technology (“IT”) security can take a
variety of forms. Hackers develop and deploy viruses, worms, and other malicious
software programs that attack our products and services and gain access to our
networks and data centers. Groups of hackers may also act in a coordinated
manner to launch distributed denial of service attacks, or other coordinated
attacks. Sophisticated organizations, individuals, or governments launch
targeted attacks to gain access to our network. Breaches of our network or data
security could disrupt and compromise the security of our internal 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
competitive position, result in theft or misuse of our intellectual property, 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. These practices
can enhance efficiency and business insight, but they also present risks that
our business policies and internal security controls may not keep pace with the
speed of these changes.

Security of our customers’ products and services

Security threats are a particular challenge to companies like us whose business
is technology products and services. The threats to our own IT infrastructure
also affect our customers. Customers using our cloud-based services rely on the
security of our infrastructure to ensure the reliability of our services and the
protection of their data. Hackers tend to focus their efforts on the most
popular operating systems, programs, and services, including many of ours, and
we expect them to continue to do so. The security of our products and services
is an important consideration in our customers’ purchasing decisions.

We devote significant resources to defend against security threats, both to our
internal IT systems and those of our customers. These include:

 

  •   engineering more secure products and services;


 

     •   enhancing security and reliability features in our products and services, 
         and continuously evaluating and updating those security and reliability   
         features;                                                                 


 

     •   improving the deployment of software updates to address security          
         vulnerabilities;                                                          


 

     •   investing in mitigation technologies that help to secure customers from   
         attacks even when software updates are not deployed;                      


 

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     •   protecting the digital security infrastructure that ensures the integrity 
         of our products and services;                                             


 

     •   helping our customers make the best use of our products and services to   
         protect against computer viruses and other attacks; and                   


 

     •   providing customers online automated security tools, published security   
         guidance, and security software such as firewalls and anti-virus software.


The cost of these steps could reduce our operating margins. Despite these
efforts, actual or perceived security vulnerabilities in our products and
services could cause significant reputational harm and lead some customers to
reduce or delay future purchases of products or subscriptions to services, or to
use competing products or services. Customers may also increase their
expenditures on protecting their existing computer systems from attack, which
could delay adoption of additional products or services. Any of these actions by
customers could adversely affect our revenue. Actual or perceived
vulnerabilities may lead to claims against us. Although our license agreements
typically contain provisions that eliminate or limit our exposure to such
liability, there is no assurance these provisions will withstand legal
challenges. Legislative or regulatory action may increase the costs to develop
or implement our products and services.

Improper disclosure 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. At the same time, the continued
occurrence of high-profile data breaches provides evidence of an external
environment increasingly hostile to information security. This environment
demands that we continuously improve our design and coordination of security
controls across our business groups and geographies. Despite these efforts, it
is possible our security controls over personal data, our training of employees
and vendors on data security, and other practices we follow may not prevent the
improper disclosure of personally identifiable information that we or our
vendors store and manage. Improper disclosure of this information could harm our
reputation, lead to legal exposure to customers, 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 to store
and process personal data on premise or, increasingly, in a cloud-based
environment we host. We believe consumers using our email, messaging, storage,
sharing, and social networking services will increasingly want efficient,
centralized methods of choosing their privacy preferences and controlling their
data. Perceptions that our products or services do not adequately protect the
privacy of personal information could inhibit sales of our products or services,
and could constrain consumer and business adoption of our cloud-based solutions.

We may experience outages, data losses, and disruptions of our online services
if we fail to maintain an adequate operations infrastructure.  Our increasing
user traffic and the complexity of our products and services demand more
computing power. We have spent and expect to continue to spend substantial
amounts to purchase or lease data centers and equipment and to upgrade our
technology and network infrastructure to handle more traffic on our websites and
in our data centers, and to introduce new products and services and support
existing services such as Bing, Exchange Online, Office 365, SharePoint Online,
SkyDrive, Skype, Xbox LIVE, Windows Azure, Outlook.com, and Microsoft Office Web
Apps. We also are growing our business of providing a platform and back-end
hosting for services provided by third-party businesses to their end customers.
Maintaining and expanding this infrastructure is expensive and complex.
Inefficiencies or operational failures, including temporary or permanent loss of
customer data, could diminish the quality of our products, services, and user
experience resulting in contractual liability, claims by customers and other
third parties, damage to our reputation and loss of current and potential users,
subscribers, and advertisers, each of which may harm our operating results and
financial condition.

We are subject to government litigation and regulatory activity that may limit
how we design and market our products.  As a leading global software maker, we
are closely scrutinized by government agencies under U.S. and foreign
competition laws. Some jurisdictions also provide private rights of action for
competitors or consumers to assert claims of anti-competitive conduct. For
example, we were sued on competition law grounds by the U.S. Department of
Justice, 18 states, and the District of Columbia in the late 1990s. The
resolution of the government lawsuits imposed various constraints on our Windows
operating system businesses. Although these constraints expired in May 2011, we
expect that federal and state antitrust authorities will continue to closely
scrutinize our business.

 

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                                     PART I

                                    Item 1A

 

The European 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. In 2004, the Commission ordered us to create new versions of
Windows that do not include certain multimedia technologies and to provide our
competitors with specifications for how to implement certain proprietary Windows
communications protocols in their own products. In 2009, the Commission accepted
a set of commitments offered by Microsoft to address the Commission’s concerns
relating to competition in Web browsing software, including an undertaking to
address Commission concerns relating to interoperability. These 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.

Government regulatory actions and court decisions such as these may hinder our
ability to provide the benefits of our software to consumers and businesses,
thereby reducing the attractiveness of our products and the revenue that come
from them. New competition law actions could be initiated at any time. 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.                         


 

     •   The rulings described above may be used as precedent in other competition 
         law proceedings.                                                          


 

     •   We are subject to a variety of ongoing commitments as a result 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. For  
         example, in July 2012, we announced that, for some PCs sold in Europe, we 
         were not in compliance with our 2009 agreement to display a “Browser      
         Choice Screen” on Windows PCs where Internet Explorer is the default      
         browser. As a result, the European Commission imposed a fine of           
         €561 million (approximately $733 million).                                


Our products and online services offerings, including new technologies we
develop or acquire such as Skype, are subject to government regulation in some
jurisdictions, including in areas of user privacy, telecommunications, data
protection, and online content. The application of 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, as well as 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
penalties being imposed on us or orders that we stop the alleged noncompliant
activity.

Our business depends on our ability to attract and retain talented
employees.  Our business is based on successfully attracting and retaining
talented employees. The market for highly skilled workers and leaders in our
industry is extremely competitive. We are limited in our ability to recruit
internationally by restrictive domestic immigration laws. If we are less
successful in our recruiting efforts, or if we are unable to retain key
employees, 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.

Delays in product development schedules may adversely affect our revenue.  The
development of software products is a complex and time-consuming process. New
products and enhancements to existing products can require long development and
testing periods. Our increasing focus on devices and cloud-based services also
presents new and complex development issues. Significant delays in new product
or service releases or significant problems in creating new products or services
could adversely affect our revenue.

 

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                                     PART I

                                    Item 1A

 

Adverse economic or market conditions may harm our business.  Unfavorable
changes in economic conditions, including inflation, recession, or other changes
in economic conditions, may result in 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 also 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 result in 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 unusual events that affect global financial markets. A
significant part of our investment portfolio consists of U.S. government
securities. If global credit and equity markets experience prolonged periods of
decline, or if there is a downgrade of U.S. government debt, our investment
portfolio may be adversely impacted 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 financial results.

We have claims and lawsuits against us that may result in adverse outcomes.  We
are subject to a variety of claims and lawsuits. 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 on our
financial statements also could occur for the period in which the effect of an
unfavorable final outcome becomes probable and reasonably estimable.

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 ordinary course of
our business, there are many transactions and calculations where the ultimate
tax determination is uncertain. We regularly are under audit by tax authorities.
Economic and political pressures to increase tax revenues in various
jurisdictions may make resolving tax disputes more difficult. Although we
believe our tax estimates are reasonable, the final determination of tax audits
and any related litigation could be materially different from our historical
income tax provisions and accruals. The results of an audit or litigation could
have a material effect on our financial statements in the period or periods for
which that determination is made.

We earn a significant amount of our operating income from outside the U.S., and
any repatriation of funds currently held in foreign jurisdictions to the U.S.
may result in higher effective tax rates for the company. In addition, there
have been proposals from Congress to change U.S. tax laws that would
significantly impact how U.S. multinational corporations are taxed on foreign
earnings. Although we cannot predict whether or in what form any proposed
legislation may pass, if enacted it could have a material adverse impact on our
tax expense and cash flows.

Our hardware and software products may experience quality or supply
problems.  Our vertically-integrated hardware products such as the Xbox 360
console, Surface, and other hardware devices we design 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 if we fail
to detect or effectively address such issues through design, testing, or
warranty repairs. We obtain some components of our hardware devices from sole
suppliers. Our competitors use some of the same suppliers and their demand for
hardware components can affect the amount of capacity available to us. If a
component delivery from a sole-source supplier is delayed or becomes unavailable
or industry shortages occur, we may be unable to obtain timely replacement
supplies, resulting in reduced sales. Component shortages, excess or obsolete
inventory, or price reductions resulting in inventory adjustments may increase
our cost of revenue. Xbox 360 consoles and Surface are assembled in Asia;
disruptions in the supply chain may result in shortages that would affect our
revenue and operating margins. These same risks would apply to any other
vertically-integrated hardware and software products we may offer.

Our stand-alone software products also may experience quality or reliability
problems. The highly sophisticated software products we develop may contain bugs
and other defects that interfere with their intended operation. Any defects we
do not detect and fix in pre-release testing could result in reduced sales and
revenue, damage to our

 

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                                     PART I

                                  Item 1A, 1B

 

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.

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 result in an impairment of goodwill or intangibles.
Under accounting principles generally accepted in the United States, 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 considered a
change in circumstances, indicating that the carrying value of our goodwill or
amortizable intangible assets may not be recoverable, include a decline in stock
price and market capitalization, reduced future cash flow estimates, and slower
growth rates in our industry. We may be required to record a significant charge
in our financial statements during the period in which any impairment of our
goodwill or amortizable intangible assets is determined, negatively impacting
our results of operations. For example, in the fourth quarter of fiscal year
2012, we recorded a $6.2 billion charge for the impairment of goodwill in our
Online Services Division business segment.

We operate a global business that exposes us to additional risks.  We operate in
over 100 countries and a significant part of our revenue comes from
international sales. Competitive or regulatory pressure to make our pricing
structure uniform might require that we reduce the sales price of our software
in the U.S. and other countries. Operations outside the U.S. may be affected by
changes in trade protection laws, policies and measures, and other regulatory
requirements affecting trade and investment. The Foreign Corrupt Practices Act
and local laws (“Anti-Corruption Laws”) prohibit corrupt payments by our
employees, vendors, or agents. While we devote substantial resources to our
global compliance programs and have implemented certain policies, training, and
internal controls designed to reduce the risk of corrupt payments, if we fail to
comply with Anti-Corruption Laws, we may be exposed to significant fines and
penalties. Emerging markets are a significant focus of our international growth
strategy. The developing nature of these markets presents a number of risks.
Deterioration of social, political, labor, or economic conditions in a specific
country or region, such as current uncertainties relating to European economic
weakness, and difficulties in staffing and managing foreign operations, may also
adversely affect our operations or financial results. Although we hedge a
portion of our international currency exposure, significant fluctuations in
exchange rates between the U.S. dollar and foreign currencies may adversely
affect our revenue.

Catastrophic events or geo-political conditions may disrupt our business.  A
disruption or failure of our systems or operations because of a major
earthquake, weather event, cyber-attack, terrorist attack, or other catastrophic
event could cause delays in completing sales, providing services, or performing
other mission-critical functions. Our corporate headquarters, a significant
portion of our research and development activities, and certain other critical
business operations are located in the Seattle, Washington area, and we have
other business operations in the Silicon Valley area of California, both of
which are near major earthquake faults. A catastrophic event that results in the
destruction or disruption of any of our critical business or IT systems could
harm our ability to conduct normal business operations. Our move toward
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 on our operating results. 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 result in supply chain disruptions for hardware
manufacturers, either of which may adversely affect our revenue. The long-term
effects of climate change on the global economy in general or the IT industry in
particular are unclear. Environmental regulations or changes in the supply,
demand or available sources of energy 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.

                       ITEM 1B. UNRESOLVED STAFF COMMENTS

We have received no written comments regarding our periodic or current reports
from the staff of the SEC that were issued 180 days or more preceding the end of
our fiscal year 2013 that remain unresolved.

 

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                                   PART I, II

                                Item 2, 3, 4, 5

 

                               ITEM 2. PROPERTIES

Our corporate offices consist of approximately 15 million square feet of office
space located in King County, Washington: 10 million square feet of owned space
situated on approximately 500 acres of land we own at our corporate campus in
Redmond, Washington and approximately five million square feet of space we
lease. We own approximately three million additional square feet of office and
data center space domestically (outside of the Puget Sound corporate campus) and
lease many sites domestically totaling approximately four million square feet of
office and data center space.

We occupy many sites internationally, totaling approximately three million
square feet that is owned and approximately nine million square feet that is
leased. International facilities that we own include: our development center in
Hyderabad, India; our European operations center in Dublin, Ireland; a research
and development campus in Beijing, China; and facilities in Reading, UK. The
largest leased office spaces include the following locations: Beijing and
Shanghai, China; Tokyo, Japan; Unterschleissheim, Germany; Paris, France;
Dublin, Ireland; Bangalore, India; Reading, UK; Vedbaek, Denmark; and
Mississauga, Canada. In addition to the above locations, we have a disk
duplication and digital distribution facility in Humacao, Puerto Rico, a
facility in Singapore for our Asia Pacific operations center and regional
headquarters, and various product development facilities, both domestically and
internationally, as described in the “Research and Development” section of
Item 1 of this Form 10-K.

Our facilities are fully used for current operations of all segments, and
suitable additional spaces are available to accommodate expansion needs. We have
a development agreement with the City of Redmond under which we may currently
develop approximately 1.6 million square feet of additional facilities at our
corporate campus in Redmond, Washington.

                           ITEM 3. LEGAL PROCEEDINGS

See Note 17 – Contingencies of the Notes to Financial Statements (Part II,
Item 8 of this Form 10-K) for information regarding legal proceedings in which
we are involved.

                        ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

                                    PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND
                     ISSUER PURCHASES OF EQUITY SECURITIES

                            MARKET AND STOCKHOLDERS

Our common stock is traded on the NASDAQ Stock Market under the symbol MSFT. On
July 18, 2013, there were 119,862 registered holders of record of our common
stock. The high and low common stock sales prices per share were as follows:

 

 Quarter Ended        September 30       December 31      March 31      June 30       Fiscal Year  
 ------------------------------------------------------------------------------------------------ -
                                                                                  
 Fiscal Year 2013                                                                                  
                                                                                  
 High               $        31.61     $       30.25     $   28.66     $  35.78     $       35.78  
 Low                $        28.54     $       26.26     $   26.28     $  28.11     $       26.26  
 ------------------------------------------------------------------------------------------------ -
                                                                                  
 Fiscal Year 2012                                                                                  
                                                                                  
 High               $        28.15     $       27.50     $   32.95     $  32.89     $       32.95  
 Low                $        23.79     $       24.26     $   26.39     $  28.32     $       23.79  
 ------------------------------------------------------------------------------------------------ -


 

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                                    PART II

                                  Item 5, 6, 7

 

                        DIVIDENDS AND SHARE REPURCHASES

See Note 18 – Stockholders’ Equity of the Notes to Financial Statements (Part
II, Item 8 of this Form 10-K) for information regarding dividends and share
repurchases by quarter. Following are our monthly stock repurchases for the
fourth quarter of fiscal year 2013, all of which were made as part of publicly
announced plans or programs:

 

                                                                                    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)  
                                                                                                      
April 1, 2013 – April 30, 2013                         0     $       0.00                         0     $                       4,614  
May 1, 2013 – May 31, 2013                     7,002,462     $      32.61                 7,002,462     $                       4,386  
June 1, 2013 – June 30, 2013                  23,632,259     $      32.65                23,632,259     $                       3,614  
-------------------------------------------------------- -   -- --------- -   -- ------------------ -   ---- ------------------------ -
                                              30,634,721                                 30,634,721                                    
                                           -- ---------- -                    -- ------------------ -                                  


The repurchases were made using cash resources and occurred either in the open
market or through the exercise of call options with a certain counterparty.

                        ITEM 6. SELECTED FINANCIAL DATA

                              FINANCIAL HIGHLIGHTS

 

(In millions, except per                                                                                            
share data)                                                                                                           
------------------------------------------------------------------------------------------------------------------- --
                                                                                                       
Year Ended June 30,                   2013                2012                 2011            2010            2009   
                                                                                                       
Revenue                         $   77,849          $   73,723           $   69,943       $  62,484       $  58,437   
Operating income                $   26,764  (a)     $   21,763   (b)     $   27,161       $  24,098       $  20,363   
Net income                      $   21,863  (a)     $   16,978   (b)     $   23,150       $  18,760       $  14,569   
Diluted earnings per share      $     2.58  (a)     $     2.00   (b)     $     2.69       $    2.10       $    1.62   
Cash dividends declared per                                                                                         
share                           $     0.92          $     0.80           $     0.64       $    0.52       $    0.52   
Cash, cash equivalents, and                                                                                         
short-term investments          $   77,022          $   63,040           $   52,772       $  36,788       $  31,447   
Total assets                    $  142,431          $  121,271           $  108,704       $  86,113       $  77,888   
Long-term obligations           $   26,070          $   22,220           $   22,847       $  13,791       $  11,296   
Stockholders’ equity            $   78,944          $   66,363           $   57,083       $  46,175       $  39,558   


--------------------------------------------------------------------------------
 

(a) Includes a charge related to a fine imposed by the European Commission in    
    March 2013 which decreased operating income and net income by $733 million   
    (€561 million) and diluted earnings per share by $0.09. Also includes a      
    charge for Surface RT inventory adjustments recorded in the fourth quarter of
    fiscal year 2013, which decreased operating income by $900 million, net      
    income by $596 million, and diluted earnings per share by $0.07.             


(b) Includes a goodwill impairment charge related to our Online Services Division
    business segment which decreased operating income and net income by $6.2     
    billion and diluted earnings per share by $0.73.                             


ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
                                 OF OPERATIONS

The following Management’s Discussion and Analysis (“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 financial statements and the accompanying Notes to
Financial Statements.

                                    OVERVIEW

Microsoft is a technology leader focused on helping people and businesses
throughout the world realize their full potential. We create technology that
transforms the way people work, play, and communicate across a wide range of
computing devices.

 

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                                    PART II

                                     Item 7

 

We generate revenue by developing, licensing, and supporting a wide range of
software products, by offering an array of services, including cloud-based
services to consumers and businesses, by designing and selling devices that
integrate with our cloud-based services, and by 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, and income taxes.

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, industry trends, and
competitive forces.

Key Opportunities and Investments

Based on our assessment of key technology trends and our broad focus on
long-term research and development of new products and services, we see
significant opportunities to generate future growth.

We invest research and development resources in new products and services in
these areas. The capabilities and accessibility of PCs, tablets, phones,
televisions, and other devices powered by rich software platforms and
applications continue to grow. With this trend, we believe the full potential of
software will be seen and felt in how people use these devices and the
associated services at work and in their personal lives.

Devices with end-user services

We work with an ecosystem of partners to deliver a broad spectrum of Windows
devices. In some cases, we build our own devices, as we have chosen to do with
Xbox and Surface. In all our work with partners and on our own devices, we focus
on delivering seamless services and experiences across devices. As consumer
services and hardware advance, we expect they will continue to better complement
one another, connecting the devices people use daily to unique communications,
productivity, and entertainment services from Microsoft and our partners and
developers around the world.

Windows 8 reflects this shift. Launched in October 2012, Windows 8 was designed
to unite the light, thin, and convenient aspects of a tablet with the power of a
PC. The Windows 8 operating system includes the Windows Store, which offers a
large and growing number of applications from Microsoft and partners for both
business and consumer customers.

Going forward, our strategy will focus on creating a family of devices and
services for individuals and businesses that empower people around the globe at
home, at work, and on the go, for the activities they value most. This strategy
will require investment in datacenters and other infrastructure to support our
services, and will bring continued competition with Apple, Google, and other
well-established and emerging competitors. We believe our history of powering
devices such as Windows PCs and Xbox, as well as our experience delivering
high-value experiences through Office and other applications, will position us
for future success.

Services for the enterprise

Today, businesses face important opportunities and challenges. Enterprises are
asked to deploy technology that drives business strategy forward. They decide
what solutions will make employees more productive, collaborative, and
satisfied, or connect with customers in new and compelling ways. They work to
unlock business insights from a world of data. At the same time, they must
manage and secure corporate information that employees access across a growing
number of personal and corporate devices.

 

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                                    PART II

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To address these opportunities, businesses look to our world-class business
applications like Microsoft Dynamics, Office, Exchange, SharePoint, Lync,
Yammer, and our business intelligence solutions. They rely on our technology to
manage employee corporate identity and to protect their corporate data. And,
increasingly, businesses of all sizes are looking to Microsoft to realize the
benefits of the cloud.

Helping businesses move to the cloud is one of our largest opportunities.
Cloud-based solutions provide customers with software, services, and content
over the Internet by way of shared computing resources located in centralized
data centers. The shift to the cloud is driven by three important economies of
scale: larger data centers can deploy computational resources at significantly
lower cost per unit than smaller ones; larger data centers can coordinate and
aggregate diverse customer, geographic, and application demand patterns
improving the utilization of computing, storage, and network resources; and
multi-tenancy lowers application maintenance labor costs for large public
clouds. Because of the improved economics, the cloud offers unique levels of
elasticity and agility that enable new solutions and applications. For
businesses of all sizes, the cloud creates the opportunity to focus on
innovation while leaving non-differentiating activities to reliable and
cost-effective providers.

Unique to Microsoft, we continue to design and deliver cloud solutions that
allow our customers to use both the cloud and their on-premise assets however
best suits their own needs. For example, a company can choose to deploy Office
or Microsoft Dynamics on premise, as a cloud service, or a combination of both.
With Windows Server 2012, Windows Azure, and System Center infrastructure,
businesses can deploy applications in their own datacenter, a partner’s
datacenter, or in Microsoft’s datacenter with common security, management, and
administration across all environments, with the flexibility and scale they
desire. These hybrid capabilities allow customers to fully harness the power of
the cloud so they can achieve greater levels of efficiency and tap new areas of
growth.

Our future opportunity

There are several distinct areas of technology that we are focused on driving
forward. Our goal is to lead the industry in these areas over the long-term,
which we expect will translate to sustained growth well into the future. We are
investing significant resources in:

 

     •   Developing new form factors that have increasingly natural ways to use    
         them, including touch, gesture, and speech.                               


 

     •   Applying machine learning to make technology more intuitive and able to   
         act on our behalf, instead of at our command.                             


 

     •   Building and running cloud-based services in ways that unleash new        
         experiences and opportunities for businesses and individuals.             


 

     •   Establishing our Windows platform across the PC, tablet, phone, server,   
         and cloud to drive a thriving ecosystem of developers, unify the          
         cross-device user experience, and increase agility when bringing new      
         advances to market.                                                       


 

     •   Delivering new high-value experiences with improvements in how people     
         learn, work, play, and interact with one another.                         


We believe the breadth of our devices and services portfolio, our large, global
partner and customer base, and the growing Windows ecosystem position us to be a
leader in these areas.

Economic Conditions, Challenges, and Risks

The market for software, devices, and cloud-based services is dynamic and highly
competitive. Some of our traditional businesses such as the Windows operating
system are in a period of transition. Our competitors are developing new devices
and deploy 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. The Windows ecosystem must continue to
evolve and adapt, over an extended time, in pace with this changing environment.
To support our strategy of offering

 

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                                    PART II

                                     Item 7

 

a family of devices and services designed to empower our customers for the
activities they value most, we announced a functional realignment in July 2013.
Through this realignment our goal is to become more nimble, collaborative,
communicative, motivated, and decisive. Even if we achieve these benefits, the
investments we are making in devices and infrastructure to support our
cloud-based services will increase our operating costs and may decrease our
operation margins.

We prioritize our investments among the highest long-term growth opportunities.
These investments require significant resources and are multi-year in nature.
The products and services we bring to market may be developed internally, as
part of a partnership or alliance, or through acquisition.

Our success is highly dependent on our ability to attract and retain qualified
employees. We hire a mix of university and industry talent worldwide. Microsoft
competes for talented individuals worldwide by offering broad customer reach,
scale in resources, and competitive compensation.

Aggregate demand for our software, services, and hardware is correlated to
global macroeconomic factors, which remain dynamic. See a discussion of these
factors and other risks under Risk Factors (Part I, Item 1A of this Form 10-K).

Seasonality

Our revenue historically has fluctuated quarterly and has generally been highest
in the second quarter of our fiscal year due to corporate calendar year-end
spending trends in our major markets and holiday season spending by consumers.
Our Entertainment and Devices Division is particularly seasonal as its products
are aimed at the consumer market and are in highest demand during the holiday
shopping season. Typically, the Entertainment and Devices Division has generated
approximately 40% of its yearly revenue in our second fiscal quarter.

Unearned Revenue

Quarterly and annual revenue may be impacted by the deferral of revenue. See the
discussions below regarding revenue deferred on sales of Windows 7 with an
option to upgrade to Windows 8 Pro at a discounted price (the “Windows Upgrade
Offer”) and sales of the previous version of the Microsoft Office system with a
guarantee to be upgraded to the new Office at minimal or no cost (the “Office
Upgrade Offer”, for the offer relating to the new Office, and “the 2010 Office
Upgrade Offer” for the prior offer relating to Office 2010).

If our customers elect 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.

                             RESULTS OF OPERATIONS

Summary

 

                                                                                           Percentage        Percentage 
(In millions, except percentages and per                                                  Change 2013       Change 2012 
share amounts)                                     2013          2012          2011       Versus 2012       Versus 2011  
----------------------------------------------------------------------------------------------------------------------- -
                                                                                                        
Revenue                                       $  77,849     $  73,723     $  69,943                6%                5%  
Operating income                              $  26,764     $  21,763     $  27,161               23%             (20)%  
Diluted earnings per share                    $    2.58     $    2.00     $    2.69               29%             (26)%  
----------------------------------------------------------------------------------------------------------------------- -


Fiscal year 2013 compared with fiscal year 2012

Revenue increased, primarily due to higher revenue from Server and Tools as well
as revenue from new products and services, including Windows 8, Surface, and the
new Office, offset in part by the impact on revenue of a decline in the x86 PC
market.

 

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Operating income grew, primarily due to the $6.2 billion goodwill impairment
charge related to our OSD business recorded during the prior year. Other key
changes in cost of revenue and operating expenses were:

 

     •   Cost of revenue increased $2.7 billion or 16%, reflecting increased       
         product costs associated with Surface and Windows 8, including an         
         approximately $900 million charge for Surface RT inventory adjustments,   
         higher headcount-related expenses, payments made to Nokia related to joint
         strategic initiatives, royalties on Xbox LIVE content, and retail stores  
         expenses, offset in part by decreased costs associated with lower sales of
         Xbox 360 consoles and decreased traffic acquisition costs.                


 

     •   Sales and marketing expenses increased $1.4 billion or 10%, reflecting    
         advertising of Windows 8 and Surface.                                     


 

     •   Research and development expenses increased $600 million or 6%, due mainly
         to higher headcount-related expenses, largely related to the Entertainment
         and Devices Division.                                                     


 

     •   General and administrative expenses increased $580 million or 13%, due to 
         higher legal charges, primarily the EU fine of $733 million.              


Fiscal year 2012 compared with fiscal year 2011

Revenue increased primarily due to strong sales of Server and Tools products and
services and the 2010 Microsoft Office system, offset in part by the decline in
Windows operating system revenue primarily due to the deferral of $540 million
of revenue relating to the Windows Upgrade Offer. Revenue in fiscal year 2012
also included Skype revenue from the date of acquisition.

Operating income decreased reflecting a goodwill impairment charge of $6.2
billion related to our OSD business segment. Other key changes in cost of
revenue and operating expenses were:

 

     •   Cost of revenue increased $2.0 billion or 13%, reflecting higher costs    
         associated with providing Server and Tools products and services, payments
         made to Nokia related to joint strategic initiatives, higher Xbox 360     
         royalty costs, and other changes in the mix of products and services sold.


 

     •   Research and development expenses increased $768 million or 8%, due mainly
         to higher headcount-related expenses.                                     


 

     •   General and administrative expenses increased $347 million or 8%, due     
         mainly to higher headcount-related expenses and the full year impact of   
         new Puerto Rican excise taxes, offset in part by decreased legal charges. 


Headcount-related expenses were higher across the company reflecting a 4%
increase in headcount from June 30, 2011 and changes in our employee
compensation program.

Fiscal year 2012 diluted earnings per share were negatively impacted by the
non-tax deductible goodwill impairment charge, which decreased diluted earnings
per share by $0.73. Fiscal year 2011 net income and diluted earnings per share
reflected a partial settlement with the U.S. Internal Revenue Service (“I.R.S.”)
and higher other income. The partial settlement with the I.R.S. added $461
million to net income and $0.05 to diluted earnings per share in fiscal year
2011.

                    SEGMENT REVENUE/OPERATING INCOME (LOSS)

The revenue and operating income (loss) amounts in this section are presented on
a basis consistent with accounting principles generally accepted in the U.S.
(“U.S. GAAP”) and include certain reconciling items attributable to each of the
segments. Segment information appearing in Note 21 – Segment Information and
Geographic Data of the Notes to Financial Statements (Part II, Item 8 of this
Form 10-K) is presented on a basis consistent with our internal management
reporting. Certain corporate-level activity has been excluded from segment
operating results and is analyzed separately. We have recast certain prior
period amounts within this MD&A to conform to the way we internally managed and
monitored segment performance during fiscal year 2013, reflecting immaterial
movements of

 

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business activities between segments and changes in cost allocations. In July
2013, we announced a change in organizational structure as part of our
transformation to a devices and services company. As we evolve how we allocate
resources and analyze performance in the new structure, it is possible that our
segments may change.

Windows Division

 

                                                                                         Percentage          Percentage 
                                                                                        Change 2013         Change 2012 
(In millions, except percentages)          2013            2012            2011         Versus 2012         Versus 2011  
----------------------------------------------------------------------------------------------------------------------- -
                                                                                                      
Revenue                               $  19,239       $  18,400       $  19,061                  5%                (3)%  
Operating income                      $   9,504       $  11,555       $  12,280               (18)%                (6)%  


--------------------------------------------------------------------------------
Windows Division develops and markets operating systems for computing devices,
related software and online services, Surface RT and Pro devices, and PC
accessories. This collection of software, hardware, and services is designed to
empower individuals, companies, and organizations and to simplify everyday tasks
through seamless operations across the user’s hardware and software. The general
availability of Surface RT and Windows 8 started October 26, 2012. The general
availability of Surface Pro started February 9, 2013.

Currently, approximately 65% of total Windows Division revenue comes from
Windows operating systems purchased by original equipment manufacturers (“OEMs”)
and pre-installed on devices they sell. The remaining Windows Division revenue
is generated by commercial and retail sales of Windows, Surface, PC accessories,
and online advertising.

Fiscal year 2013 compared with fiscal year 2012

Windows Division revenue increased $839 million. Surface revenue was $853
million. Revenue from commercial licensing of Windows increased $487 million,
while unearned revenue from commercial licensing also increased, reflecting
continued support of our platform. In addition, we recognized $540 million of
previously deferred revenue related to the expiration of the Windows Upgrade
Offer. Partially offsetting these increases was a decrease in OEM revenue.

OEM revenue decreased 3%. Excluding the impact of the Windows Upgrade Offer, OEM
revenue decreased 10%. This decrease primarily reflects the impact on revenue of
the decline in the x86 PC market, which we estimate declined approximately 9%.

In May 2013, we announced that we had surpassed 100 million licenses sold for
Windows 8.

Windows Division operating income decreased, primarily due to higher cost of
revenue and sales and marketing expenses, offset in part by revenue growth. Cost
of revenue increased $1.8 billion, reflecting a $1.6 billion increase in product
costs associated with Surface and Windows 8, including a charge for Surface RT
inventory adjustments of approximately $900 million. Sales and marketing
expenses increased $1.0 billion or 34%, reflecting an $898 million increase in
advertising costs associated primarily with Windows 8 and Surface.

Fiscal year 2012 compared with fiscal year 2011

Windows Division revenue reflected relative performance in the PC market
segments. We estimate that sales of PCs to businesses grew approximately 4% and
sales of PCs to consumers decreased 1%. Excluding a decline in sales of
netbooks, we estimate that sales of PCs to consumers grew approximately 5%.
Taken together, the total PC market increased an estimated 0% to 2%. Relative to
PC market growth, Windows Division revenue was negatively impacted by higher
growth in emerging markets, where average selling prices are lower than
developed markets, and the deferral of $540 million of revenue relating to the
Windows Upgrade Offer.

Windows Division operating income decreased, due mainly to lower revenue and a
$172 million or 11% increase in research and development expenses, primarily
associated with the Windows 8 operating system.

 

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Server and Tools

 

                                                                                         Percentage          Percentage 
                                                                                        Change 2013         Change 2012 
(In millions, except percentages)          2013            2012            2011         Versus 2012         Versus 2011  
----------------------------------------------------------------------------------------------------------------------- -
                                                                                                      
Revenue                               $  20,281       $  18,534       $  16,559                  9%                 12%  
Operating income                      $   8,164       $   7,235       $   6,105                 13%                 19%  


--------------------------------------------------------------------------------
Server and Tools develops and markets technology and related services that
enable information technology professionals and their systems to be more
productive and efficient. Server and Tools product and service offerings include
Windows Server, Microsoft SQL Server, Windows Azure, Visual Studio, System
Center products, Windows Embedded device platforms, and Enterprise Services.
Enterprise Services comprise Premier product support services and Microsoft
Consulting Services. We also offer developer tools, training, and certification.
Approximately 80% of Server and Tools revenue comes from product revenue,
including purchases through volume licensing programs, licenses sold to OEMs,
and retail packaged product, while the remainder comes from Enterprise Services.

Fiscal year 2013 compared with fiscal year 2012

Server and Tools revenue increased in both product sales and Enterprise
Services. Product revenue increased $1.3 billion or 9%, driven primarily by
growth in Microsoft SQL Server, System Center, and Windows Server. Enterprise
Services revenue grew $434 million or 11%, due to growth in both Premier product
support and consulting services.

Server and Tools operating income increased, primarily due to revenue growth,
offset in part by higher cost of revenue and sales and marketing expenses. Cost
of revenue grew $589 million or 15%, reflecting a $269 million increase in
headcount-related expenses and a $169 million increase in datacenter expenses.
Headcount-related expenses increased due mainly to higher Enterprise Services
headcount supporting revenue growth, while datacenter expenses grew primarily to
support our online services offerings. Sales and marketing expenses grew $160
million or 3%, reflecting increased fees paid to third-party enterprise software
advisors and corporate sales and marketing activities.

Fiscal year 2012 compared with fiscal year 2011

Server and Tools revenue increased in both product sales and Enterprise
Services. Product revenue increased $1.4 billion or 11%, driven primarily by
growth in SQL Server, Windows Server, and System Center, reflecting continued
adoption of the Windows platform. Enterprise Services revenue grew $585 million
or 17%, due to growth in both Premier product support and consulting services.

Server and Tools operating income increased primarily due to revenue growth,
offset in part by higher costs of providing products and services and increased
sales and marketing expenses. Cost of revenue increased $678 million or 22%,
primarily reflecting higher Enterprise Services headcount-related expenses.
Sales and marketing expenses grew $154 million or 3%, reflecting increased
corporate marketing activities.

Online Services Division

 

                                                                                            Percentage          Percentage 
                                                                                           Change 2013         Change 2012 
(In millions, except percentages)          2013             2012             2011          Versus 2012         Versus 2011  
-------------------------------------------------------------------------------------------------------------------------- -
                                                                                                         
Revenue                               $   3,201        $   2,867        $   2,607                  12%                 10%  
Operating loss                        $  (1,281 )      $  (8,125 )      $  (2,657 )                  *                   *  


--------------------------------------------------------------------------------
 

* Not meaningful


Online Services Division (“OSD”) develops and markets information and content
designed to help people simplify tasks and make more informed decisions online,
and help advertisers connect with audiences. OSD offerings include Bing, Bing
Ads, and MSN. Bing and MSN generate revenue through the sale of search and
display advertising, accounting for nearly all of OSD’s revenue.

 

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Fiscal year 2013 compared with fiscal year 2012

Online advertising revenue grew $409 million or 16% to $3.0 billion, reflecting
an increase in search advertising revenue, offset in part by a decrease in
display advertising revenue. Search revenue grew primarily due to increased
revenue per search, resulting from ongoing improvements in ad products, while
display advertising revenue decreased primarily due to industry-wide market
pressure.

OSD’s operating loss decreased, primarily due to the prior year goodwill
impairment charge of $6.2 billion. Operating loss was further reduced by higher
revenue and lower cost of revenue and operating expenses. Cost of revenue
decreased $302 million or 12%, driven by a $271 million decrease in traffic
acquisition costs as well as lower Yahoo! reimbursement costs. Sales and
marketing expenses were $120 million or 15% lower, due mainly to decreased
corporate sales and marketing activities. Research and development costs
increased $94 million or 7%, due primarily to higher headcount-related expenses
resulting mainly from increased headcount.

Fiscal year 2012 compared with fiscal year 2011

Online advertising revenue grew $317 million or 14% to $2.6 billion, reflecting
continued growth in search advertising revenue, offset in part by decreased
display advertising revenue. Search revenue grew due to increased revenue per
search, increased volumes reflecting general market growth, and share gains in
the U.S. According to third-party sources, Bing organic U.S. market share for
the month of June 2012 was approximately 16%, and grew 120 basis points year
over year. Bing-powered U.S. market share, including Yahoo! properties, was
approximately 26% for the month of June 2012, down 100 basis points year over
year.

OSD’s fiscal year 2012 operating loss reflects a goodwill impairment charge of
$6.2 billion, which we recorded as a result of our annual goodwill impairment
test in the fourth quarter. The non-cash, non-tax-deductible charge related
mainly to goodwill acquired through our 2007 acquisition of aQuantive, Inc.
Excluding the $6.2 billion goodwill impairment charge, OSD’s operating loss was
reduced by higher revenue and lower sales and marketing expenses and cost of
revenue. Sales and marketing expenses decreased $321 million or 29%, due mainly
to lower marketing spend. Cost of revenue decreased $208 million, driven by
lower Yahoo! reimbursement costs, amortization, and online operating costs.

Microsoft Business Division

 

                                                                                         Percentage          Percentage 
                                                                                        Change 2013         Change 2012 
(In millions, except percentages)          2013            2012            2011         Versus 2012         Versus 2011  
----------------------------------------------------------------------------------------------------------------------- -
                                                                                                      
Revenue                               $  24,724       $  24,111       $  22,607                  3%                  7%  
Operating income                      $  16,194       $  15,832       $  14,678                  2%                  8%  


--------------------------------------------------------------------------------
Microsoft Business Division (“MBD”) develops and markets software and online
services designed to increase personal, team, and organization productivity. MBD
offerings include the Microsoft Office system (“Office,” comprising mainly the
core Office product set, Office 365, SharePoint, Exchange, and Lync), which
generates over 90% of MBD revenue, and Microsoft Dynamics business solutions.
The general availability of the new Office started on January 29, 2013.

We evaluate MBD results based upon the nature of the end user in two primary
parts: business revenue and consumer revenue. Business revenue includes Office
revenue generated through subscription and volume licensing agreements with
software assurance, license-only agreements for Office, and Microsoft Dynamics
revenue. Consumer revenue includes revenue from retail packaged product sales
and OEM revenue.

Fiscal year 2013 compared with fiscal year 2012

MBD revenue increased reflecting growth in business revenue, partially offset by
a decline in consumer revenue. Business revenue increased $1.2 billion or 6%,
which reflects 11% growth in Office revenue from subscriptions and

 

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volume licensing agreements with software assurance, and a 12% increase in
Microsoft Dynamics revenue, offset in part by a 9% decrease in Office
license-only revenue. Consumer revenue decreased $582 million or 13%, primarily
driven by the impact on revenue of a decline in the x86 PC market.

MBD revenue for the year ended June 30, 2013 included an unfavorable foreign
currency impact of $475 million.

MBD operating income increased, primarily due to revenue growth, offset in part
by higher sales and marketing expenses and cost of revenue. Sales and marketing
expenses grew $185 million or 5%, primarily due to higher advertising expenses,
fees paid to third-party software advisors, and increased cross-platform
marketing activities. Cost of revenue grew $108 million or 6%, primarily due to
an increase in online operation and support costs.

Fiscal year 2012 compared with fiscal year 2011

MBD revenue increased primarily reflecting sales of Office. Business revenue
increased $1.7 billion or 9%, primarily reflecting growth in multi-year volume
licensing revenue, licensing of Office to transactional business customers, and
a 9% increase in Microsoft Dynamics revenue. Consumer revenue decreased $193
million or 4% due to the recognition of $254 million of revenue in the prior
year associated with the 2010 Office Upgrade Offer. Excluding the fiscal year
2011 impact associated with the 2010 Office Upgrade Offer, consumer revenue
increased $61 million, driven by increased sales of Office.

MBD revenue for the year ended June 30, 2012 included a favorable foreign
currency impact of $506 million.

MBD operating income increased, primarily due to revenue growth, offset in part
by higher cost of revenue and research and development expenses. Cost of revenue
increased $278 million or 17%, primarily due to higher online operation and
support costs. Research and development expenses increased, due mainly to an
increase in headcount-related expenses.

Entertainment and Devices Division

 

                                                                                   Percentage         Percentage 
                                                                                  Change 2013        Change 2012 
(In millions, except percentages)         2013          2012          2011        Versus 2012        Versus 2011  
---------------------------------------------------------------------------------------------------------------- -
                                                                                                
Revenue                              $  10,165      $  9,599      $  8,915                 6%                 8%  
Operating income                     $     848      $    380      $  1,261               123%              (70)%  


--------------------------------------------------------------------------------
Entertainment and Devices Division (“EDD”) develops and markets products and
services designed to entertain and connect people. EDD offerings include the
Xbox entertainment platform (which includes the Xbox 360 gaming and
entertainment console, Kinect for Xbox 360, Xbox 360 video games, Xbox LIVE, and
Xbox 360 accessories), Skype, and Windows Phone, including related patent
licensing revenue. We acquired Skype on October 13, 2011, and its results of
operations from that date are reflected in our results discussed below. In June
2013, we announced that we expect our next generation console, Xbox One, to be
available for purchase in the second quarter of fiscal year 2014.

Fiscal year 2013 compared with fiscal year 2012

EDD revenue increased, due to higher Windows Phone and Skype revenue, offset in
part by lower Xbox 360 platform revenue. Windows Phone revenue increased $1.2
billion, including an increase in patent licensing revenue and sales of Windows
Phone licenses. Skype revenue increased, due primarily to including a full year
of results in fiscal year 2013. Xbox 360 platform revenue decreased $950 million
or 12%, due mainly to lower volumes of consoles sold, offset in part by higher
Xbox LIVE revenue. We shipped 9.8 million Xbox 360 consoles during fiscal year
2013, compared with 13.0 million Xbox 360 consoles during fiscal year 2012.

EDD operating income increased, primarily due to revenue growth and lower cost
of revenue, offset in part by higher operating expenses. Sales and marketing
expenses decreased $176 million or 16%, reflecting a $248 million

 

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decrease in Xbox 360 platform marketing. Cost of revenue decreased $143 million
or 2%, due mainly to a $1.0 billion decrease in manufacturing and distribution
costs associated with lower volumes of Xbox 360 consoles sold, offset in part by
a $375 million increase in expenses for payments made to Nokia related to joint
strategic initiatives and a $273 million increase in royalties on Xbox LIVE
content. Research and development expenses increased $432 million or 28%,
reflecting $246 million higher headcount-related expenses, resulting mainly from
increased headcount in connection with the Xbox platform and Skype.

Fiscal year 2012 compared with fiscal year 2011

EDD revenue increased primarily reflecting Skype and Windows Phone revenue,
offset in part by lower Xbox 360 platform revenue. Xbox 360 platform revenue
decreased $107 million, due mainly to decreased volumes of Kinect for Xbox 360
sold and lower video game revenue, offset in part by higher Xbox LIVE revenue.
We shipped 13.0 million Xbox 360 consoles during fiscal year 2012, compared with
13.7 million Xbox 360 consoles during fiscal year 2011. Video game revenue
decreased due to strong sales of Halo Reach in the prior year.

EDD operating income decreased reflecting higher cost of revenue and operating
expenses, offset in part by revenue growth. Cost of revenue grew $896 million or
16%, primarily due to changes in the mix of products and services sold and
payments made to Nokia related to joint strategic initiatives. Research and
development expenses increased $366 million or 31%, primarily reflecting higher
headcount-related expenses. Sales and marketing expenses increased $242 million
or 27%, primarily reflecting the inclusion of Skype expenses.

Corporate-Level Activity

 

                                                                                        Percentage         Percentage 
                                                                                       Change 2013        Change 2012 
(In millions, except percentages)          2013            2012            2011        Versus 2012        Versus 2011  
--------------------------------------------------------------------------------------------------------------------- -
                                                                                                     
Corporate-level activity             $  (6,665)      $  (5,114)      $  (4,506)              (30)%              (13)%  


--------------------------------------------------------------------------------
Certain corporate-level activity is not allocated to our segments, including
costs of: broad-based sales and marketing; product support services; human
resources; legal; finance; information technology; corporate development and
procurement activities; research and development; costs of operating our retail
stores; and legal settlements and contingencies.

Fiscal year 2013 compared with fiscal year 2012

Corporate-level expenses increased, primarily due to higher legal charges from
the European Commission fine of €561 million (approximately $733 million) for
failure to comply with our 2009 agreement to display a “Browser Choice Screen”
on Windows PCs where Internet Explorer is the default browser (the “EU fine”).
Corporate-level expenses also grew due to a $350 million increase in retail
stores expenses and $287 million higher intellectual property licensing costs.

Fiscal year 2012 compared with fiscal year 2011

Corporate-level expenses increased due mainly to full year Puerto Rican excise
taxes, higher headcount-related expenses, and changes in foreign currency
exchange rates. These increases were offset in part by lower legal charges,
which were $56 million in fiscal year 2012 compared with $332 million in fiscal
year 2011.

                                COST OF REVENUE

Cost of Revenue

 

                                                                                         Percentage          Percentage 
                                                                                        Change 2013         Change 2012 
(In millions, except percentages)          2013            2012            2011         Versus 2012         Versus 2011  
----------------------------------------------------------------------------------------------------------------------- -
                                                                                                      
Cost of revenue                       $  20,249       $  17,530       $  15,577                 16%                 13%  
As a percent of revenue                     26%             24%             22%                2ppt                2ppt  


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Cost of revenue includes: manufacturing and distribution costs for products
sold, including Xbox and Surface, and programs licensed; operating costs related
to product support service centers and product distribution centers; costs
incurred to include software on PCs sold by OEMs, to drive traffic to our
websites, and to acquire online advertising space (“traffic acquisition costs”);
costs incurred to support and maintain internet-based products and services,
including datacenter costs and royalties; warranty costs; inventory valuation
adjustments; costs associated with the delivery of consulting services; and the
amortization of capitalized research and development costs.

Fiscal year 2013 compared with fiscal year 2012

Cost of revenue increased, reflecting $1.6 billion in product costs associated
with Surface and Windows 8, including a charge for Surface RT inventory
adjustments of approximately $900 million, $578 million higher headcount-related
expenses, a $375 million increase in expenses for payments to Nokia related to
joint strategic initiatives, $287 million higher intellectual property licensing
costs, a $273 million increase in royalties on Xbox LIVE content, and a $152
million increase in retail store expenses, offset in part by a $1.0 billion
decrease in manufacturing and distribution costs associated with lower volumes
of Xbox 360 consoles sold and a $431 million decrease in traffic acquisition
costs.

Fiscal year 2012 compared with fiscal year 2011

Cost of revenue increased reflecting higher headcount-related expenses, payments
made to Nokia, and changes in the mix of products and services sold.
Headcount-related expenses increased 20%, primarily related to increased
Enterprise Services headcount.

                               OPERATING EXPENSES

Research and Development

 

                                                                                       Percentage          Percentage 
                                                                                      Change 2013         Change 2012 
(In millions, except percentages)          2013           2012           2011         Versus 2012         Versus 2011  
--------------------------------------------------------------------------------------------------------------------- -
                                                                                                    
Research and development              $  10,411       $  9,811       $  9,043                  6%                  8%  
As a percent of revenue                     13%            13%            13%                0ppt                0ppt  


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

Fiscal year 2013 compared with fiscal year 2012

Research and development expenses increased, reflecting a $460 million or 6%
increase in headcount-related expenses, largely related to the Entertainment and
Devices Division.

Fiscal year 2012 compared with fiscal year 2011

Research and development expenses increased, primarily reflecting a 10% increase
in headcount-related expenses.

Sales and Marketing

 

                                                                                     Percentage         Percentage 
                                                                                    Change 2013        Change 2012 
(In millions, except percentages)         2013           2012           2011        Versus 2012        Versus 2011  
------------------------------------------------------------------------------------------------------------------ -
                                                                                                  
Sales and marketing                  $  15,276      $  13,857      $  13,940                10%               (1)%  
As a percent of revenue                    20%            19%            20%               1ppt             (1)ppt  


--------------------------------------------------------------------------------
 

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

Fiscal year 2013 compared with fiscal year 2012

Sales and marketing expenses grew, reflecting an $898 million increase in
advertising costs associated primarily with Windows 8 and Surface, $181 million
higher fees paid to third-party software advisors, and a $145 million or 2%
increase in headcount-related expenses.

Fiscal year 2012 compared with fiscal year 2011

Sales and marketing expenses decreased slightly, primarily reflecting decreased
advertising and marketing of the Xbox 360 platform, Windows Phone, and Bing,
offset in part by a 5% increase in headcount-related expenses.

General and Administrative

 

                                                                                      Percentage          Percentage 
                                                                                     Change 2013         Change 2012 
(In millions, except percentages)         2013           2012           2011         Versus 2012         Versus 2011  
-------------------------------------------------------------------------------------------------------------------- -
                                                                                                   
General and administrative            $  5,149       $  4,569       $  4,222                 13%                  8%  
As a percent of revenue                     7%             6%             6%                1ppt                0ppt  


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

Fiscal year 2013 compared with fiscal year 2012

General and administrative expenses increased due to higher legal charges from
the EU fine.

Fiscal year 2012 compared with fiscal year 2011

General and administrative expenses increased, primarily due to a 10% increase
in headcount-related expenses and a full year of Puerto Rican excise taxes,
offset in part by a decrease in legal charges.

Goodwill Impairment

We test goodwill for impairment annually on May 1 at the reporting unit level
using a fair value approach. No impairment of goodwill was identified as of
May 1, 2013. Our goodwill impairment test as of May 1, 2012, indicated that
OSD’s carrying value exceeded its estimated fair value. Accordingly, we recorded
a non-cash, non-tax deductible goodwill impairment charge of $6.2 billion during
the three months ended June 30, 2012, reducing OSD’s goodwill from $6.4 billion
to $223 million.

 

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                    OTHER INCOME (EXPENSE) AND INCOME TAXES

Other Income (Expense)

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

 

    (In millions)                                                                       
    --------------------------------------------------------------------------------- --
                                                                            
    Year Ended June 30,                                2013         2012         2011   
                                                                            
    Dividends and interest income                   $   677      $   800      $   900   
    Interest expense                                   (429 )       (380 )       (295 ) 
    Net recognized gains on investments                 116          564          439   
    Net losses on derivatives                          (196 )       (364 )        (77 ) 
    Net losses on foreign currency remeasurements       (74 )       (117 )        (26 ) 
    Other                                               194            1          (31 ) 
    ------------------------------------------------------- --   - ----- --   - ----- --
    Total                                           $   288      $   504      $   910   
                                                    - ----- --   - ----- --   - ----- --


We use derivative instruments to: manage risks related to foreign currencies,
equity prices, interest rates, and credit; enhance investment returns; and
facilitate portfolio diversification. Gains and losses from changes in fair
values of derivatives that are not designated as hedges are primarily recognized
in other income (expense). Other than those derivatives entered into for
investment purposes, such as commodity contracts, the gains (losses) are
generally economically offset by unrealized gains (losses) in the underlying
available-for-sale securities, which are recorded as a component of other
comprehensive income (“OCI”) until the securities are sold or
other-than-temporarily impaired, at which time the amounts are reclassified from
accumulated other comprehensive income (“AOCI”) into other income (expense).

Fiscal year 2013 compared with fiscal year 2012

Dividends and interest income decreased due to lower yields on our fixed-income
investments, offset in part by higher average portfolio investment balances. Net
recognized gains on investments decreased primarily due to lower gains on sales
of equity and fixed-income securities and a gain recognized on the partial sale
of our Facebook holding in the prior year, offset in part by lower
other-than-temporary impairments. Other-than-temporary impairments were $208
million in fiscal year 2013, compared with $298 million in fiscal year 2012. Net
losses on derivatives decreased due to gains on equity derivatives in the
current fiscal year as compared with losses in the prior fiscal year, and lower
losses on commodity and foreign exchange derivatives as compared to the prior
fiscal year, offset in part by losses on interest-rate derivatives in the
current fiscal year as compared to gains in the prior fiscal year. For the
current year, other reflects recognized gains on divestitures, including the
gain recognized upon the divestiture of our 50% share in the MSNBC joint
venture.

Fiscal year 2012 compared with fiscal year 2011

Dividends and interest income decreased due to lower yields on our fixed-income
investments, offset in part by higher average portfolio investment balances.
Interest expense increased due to our increased issuance of debt in the prior
year. Net recognized gains on investments increased, primarily due to higher
gains on sales of equity and fixed-income securities and a gain recognized on
the partial sale of our Facebook holding upon the initial public offering on
May 18, 2012, offset in part by higher other-than-temporary impairments.
Other-than-temporary impairments were $298 million in fiscal year 2012, compared
with $80 million in fiscal year 2011. Net losses on derivatives increased due to
losses on commodity and equity derivatives in the current fiscal year as
compared with gains in the prior fiscal year, offset in part by fewer losses on
foreign exchange contracts in the current fiscal year as compared to the prior
fiscal year. Changes in foreign currency remeasurements were primarily due to
currency movements net of our hedging activities.

 

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Income Taxes

Fiscal year 2013 compared with fiscal year 2012

Our effective tax rate for fiscal years 2013 and 2012 was approximately 19% and
24%, respectively. Our effective tax rate was lower than the U.S. federal
statutory rate primarily due to earnings taxed at lower rates in foreign
jurisdictions resulting from producing and distributing our products and
services through our foreign regional operations centers in Ireland, Singapore,
and Puerto Rico.

Our fiscal year 2013 effective rate decreased by 5% from fiscal year 2012 mainly
due to a nonrecurring $6.2 billion non-tax deductible goodwill impairment charge
that was recorded in fiscal year 2012. The goodwill impairment charge increased
our effective tax rate by 10% in fiscal year 2012. In addition, in fiscal years
2013 and 2012, we recognized a reduction of 18% and 21%, respectively, to the
effective tax rate due to foreign earnings taxed at lower rates. The decrease in
our effective tax rate for fiscal year 2013 was primarily offset by a 1%
increase related to the EU fine, which is not tax deductible.

Changes in the mix of income before income taxes between the U.S. and foreign
countries also impacted our effective tax rates and resulted primarily from
changes in the geographic distribution of and changes in consumer demand for our
products and services. As discussed above, Windows Division operating income
declined $2.1 billion in fiscal year 2013, while MBD and Server and Tools
operating income increased $362 million and $929 million, respectively, during
this same period. We supply Windows, our primary Windows Division product, to
customers through our U.S. regional operating center, while we supply the
Microsoft Office System, our primary MBD product, and our Server and Tools
products to customers through our foreign regional operations centers. In fiscal
years 2013 and 2012, our U.S. income before income taxes was $6.7 billion and
$1.6 billion, respectively, and comprised 25% and 7%, respectively, of our
income before income taxes. In fiscal years 2013 and 2012, the foreign income
before income taxes was $20.4 billion and $20.7 billion, respectively, and
comprised 75% and 93%, respectively, of our income before income taxes. The
primary driver for the increase in the U.S. income before income tax in fiscal
year 2013 was the goodwill impairment charge recorded during the prior year.

Tax contingencies and other tax liabilities were $9.4 billion and $7.6 billion
as of June 30, 2013 and 2012, respectively, and are included in other long-term
liabilities. This increase relates primarily to transfer pricing, including
transfer pricing developments in certain foreign tax jurisdictions, primarily
Denmark. While we settled a portion of the I.R.S. audit for tax years 2004 to
2006 during the third quarter of fiscal year 2011, we remain under audit for
those years. In February 2012, the I.R.S. withdrew its 2011 Revenue Agents
Report and reopened the audit phase of the examination. As of June 30, 2013, the
primary unresolved issue relates to transfer pricing which could have a
significant impact on our financial statements if not resolved favorably. We do
not believe it is reasonably possible that the total amount of unrecognized tax
benefits will significantly increase or decrease within the next 12 months
because we do not believe the remaining open issues will be resolved within the
next 12 months. We also continue to be subject to examination by the I.R.S. for
tax years 2007 to 2012.

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 2012, some of which are currently under audit by local tax authorities.
The resolutions of these audits are not expected to be material to our financial
statements.

Fiscal year 2012 compared with fiscal year 2011

Our effective tax rates for fiscal years 2012 and 2011 were approximately 24%
and 18%, respectively. Our effective tax rates were lower than the U.S. federal
statutory rate primarily due to earnings taxed at lower rates in foreign
jurisdictions resulting from producing and distributing our products and
services through our foreign regional operations centers in Ireland, Singapore,
and Puerto Rico.

Our fiscal year 2012 effective rate increased by 6% from fiscal year 2011 mainly
due to a nonrecurring $6.2 billion non-tax deductible goodwill impairment charge
that was recorded in the fourth quarter of 2012. The goodwill impairment charge
increased our effective tax rate by 10%. In addition, in fiscal years 2012 and
2011, we recognized

 

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a reduction of 21% and 16%, respectively, to the effective tax rate due to
foreign earnings taxed at lower rates. In fiscal year 2011, we settled a portion
of an I.R.S. audit of tax years 2004 to 2006, which reduced our income tax
expense for fiscal year 2011 by $461 million and reduced the effective tax rate
by 2%.

Changes in the mix of income before income taxes between the U.S. and foreign
countries also impacted our effective tax rates and resulted primarily from
changes in the geographic distribution of and changes in consumer demand for our
products and services. As discussed above, Windows Division operating income
declined $751 million in fiscal year 2012, while MBD and Server and Tools
operating income increased $1.1 billion and $1.1 billion, respectively, during
this same period. We supply Windows, our primary Windows Division product, to
customers through our U.S. regional operating center, while we supply the
Microsoft Office System, our primary MBD product, and our Server and Tools
products to customers through our foreign regional operations centers. In fiscal
years 2012 and 2011, our U.S. income before income taxes was $1.6 billion and
$8.9 billion, respectively, and comprised 7% and 32%, respectively, of our
income before income taxes. In fiscal years 2012 and 2011, the foreign income
before income taxes was $20.7 billion and $19.2 billion, respectively, and
comprised 93% and 68%, respectively, of our income before income taxes. The
primary driver for the decrease in the U.S. income before income tax in fiscal
year 2012 was the goodwill impairment charge.

                              FINANCIAL CONDITION

Cash, Cash Equivalents, and Investments

Cash, cash equivalents, and short-term investments totaled $77.0 billion as of
June 30, 2013, compared with $63.0 billion as of June 30, 2012. Equity and other
investments were $10.8 billion as of June 30, 2013, compared with $9.8 billion
as of June 30, 2012. Our short-term investments are primarily to facilitate
liquidity and for capital preservation. They consist predominantly of highly
liquid investment-grade fixed-income securities, diversified among industries
and individual issuers. The investments are predominantly U.S.
dollar-denominated securities, but also include foreign currency-denominated
securities in order to diversify risk. Our fixed-income investments are exposed
to interest rate risk and credit risk. The credit risk and average maturity of
our fixed-income portfolio are managed to achieve economic returns that
correlate to certain fixed-income indices. The settlement risk related to these
investments is insignificant given that the short-term investments held are
primarily highly liquid investment-grade fixed-income securities. While we own
certain mortgage-backed and asset-backed fixed-income securities, our portfolio
as of June 30, 2013 does not contain material direct exposure to subprime
mortgages or structured vehicles that derive their value from subprime
collateral. The majority of our mortgage-backed securities are collateralized by
prime residential mortgages and carry a 100% principal and interest guarantee,
primarily from Federal National Mortgage Association, Federal Home Loan Mortgage
Corporation, and Government National Mortgage Association.

We routinely monitor our financial exposure to both sovereign and non-sovereign
borrowers and counterparties. Our gross exposures to our customers and
investments in Portugal, Italy, Ireland, Greece, and Spain are individually and
collectively not material.

Of the cash, cash equivalents, and short-term investments at June 30, 2013,
approximately $69.6 billion was held by our foreign subsidiaries and would be
subject to material repatriation tax effects. The amount of cash, cash
equivalents, and short-term investments held by foreign subsidiaries subject to
other restrictions on the free flow of funds (primarily currency and other local
regulatory) was approximately $880 million. As of June 30, 2013, approximately
87% of the cash equivalents and short-term investments held by our foreign
subsidiaries were invested in U.S. government and agency securities,
approximately 4% were invested in corporate notes and bonds of U.S. companies,
and 2% were invested in U.S. mortgage-backed securities, all of which are
denominated in U.S. dollars.

Securities lending

We lend certain fixed-income and equity securities to increase investment
returns. The loaned securities continue to be carried as investments on our
balance sheet. Cash and/or security interests are received as collateral for the
loaned securities with the amount determined based upon the underlying security
lent and the creditworthiness of

 

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the borrower. Cash received is recorded as an asset with a corresponding
liability. Our securities lending payable balance was $645 million as of
June 30, 2013. Our average and maximum securities lending payable balances for
the fiscal year were $494 million and $1.4 billion, respectively. Intra-year
variances in the amount of securities loaned are mainly due to fluctuations in
the demand for the securities.

Valuation

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

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

Cash Flows

Fiscal year 2013 compared with fiscal year 2012

Cash flows from operations decreased $2.8 billion during the current fiscal year
to $28.8 billion, due mainly to changes in working capital, including increases
in inventory and other current assets. Cash used for financing decreased $1.3
billion to $8.1 billion, due mainly to a $3.5 billion increase in proceeds from
issuances of debt, net of repayments, offset in part by a $1.1 billion increase
in dividends paid and a $982 million decrease in proceeds from the issuance of
common stock. Cash used in investing decreased $975 million to $23.8 billion,
due mainly to an $8.5 billion decrease in cash used for acquisitions of
companies and purchases of intangible and other assets, offset in part by a $5.8
billion increase in cash used for net investment purchases, maturities, and
sales and a $2.0 billion increase in cash used for additions to property and
equipment.

Fiscal year 2012 compared with fiscal year 2011

Cash flows from operations increased $4.6 billion during fiscal year 2012 to
$31.6 billion, due mainly to increased revenue and cash collections from
customers. Cash used for financing increased $1.0 billion to $9.4 billion, due
mainly to a $6.0 billion net decrease in proceeds from issuances of debt and a
$1.2 billion increase in dividends paid, offset in part by a $6.5 billion
decrease in cash used for common stock repurchases. Cash used in investing
increased $10.2 billion to $24.8 billion, due mainly to a $10.0 billion increase
in acquisitions of businesses and purchases of intangible assets and a $1.4
billion decrease in cash from securities lending activities, partially offset by
a $1.2 billion decrease in cash used for net purchases, maturities, and sales of
investments.

 

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Debt

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

As of June 30, 2013, the total carrying value and estimated fair value of our
long-term debt, including the current portion, were $15.6 billion and $15.8
billion, respectively. This is compared to a carrying value and estimated fair
value of $11.9 billion and $13.2 billion, respectively, as of June 30, 2012.
These estimated fair values are based on Level 2 inputs.

The components of our long-term debt, including the current portion, and the
associated interest rates were as follows as of June 30, 2013:

 

                                                         Stated       Effective 
                                                       Interest        Interest 
          Due Date                     Face Value          Rate            Rate  
          --------------------------------------------------------------------- -
                                    (In millions)                                
                                                                  
          Notes                                                                  
                                                                  
          September 27, 2013      $         1,000        0.875%          1.000%  
          June 1, 2014                      2,000        2.950%          3.049%  
          September 25, 2015                1,750        1.625%          1.795%  
          February 8, 2016                    750        2.500%          2.642%  
          November 15, 2017 (a)               600        0.875%          1.084%  
          May 1, 2018 (b)                     450        1.000%          1.106%  
          June 1, 2019                      1,000        4.200%          4.379%  
          October 1, 2020                   1,000        3.000%          3.137%  
          February 8, 2021                    500        4.000%          4.082%  
          November 15, 2022 (a)               750        2.125%          2.239%  
          May 1, 2023 (b)                   1,000        2.375%          2.465%  
          May 2, 2033 (c)                     715        2.625%          2.690%  
          June 1, 2039                        750        5.200%          5.240%  
          October 1, 2040                   1,000        4.500%          4.567%  
          February 8, 2041                  1,000        5.300%          5.361%  
          November 15, 2042 (a)               900        3.500%          3.571%  
          May 1, 2043 (b)                     500        3.750%          3.829%  
          --------------------------------------- -                              
          Total                   $        15,665                                
                                  --- ----------- -                              


 

(a) In November 2012, we issued $2.25 billion of debt securities.


(b) In April 2013, we issued $1.95 billion of debt securities.


(c) In April 2013, we issued €550 million of debt securities.


Interest on the notes is paid semi-annually, except for the euro-denominated
debt securities on which interest is paid annually. As of June 30, 2013, the
aggregate unamortized discount for our long-term debt, including the current
portion, was $65 million.

Notes

The Notes are senior unsecured obligations and rank equally with our other
unsecured and unsubordinated debt outstanding.

 

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Convertible Debt

In June 2013, we paid cash of $1.25 billion for the principal amount of our zero
coupon convertible unsecured debt and elected to deliver cash for the $96
million excess obligation resulting from the conversion of the notes. Each
$1,000 principal amount of notes was convertible into 30.68 shares of Microsoft
common stock at a conversion price of $32.59 per share. As of June 30, 2012, the
net carrying amount of the convertible debt and the unamortized discount were
$1.2 billion and $19 million, respectively.

In connection with the issuance of the notes in 2010, we entered into capped
call transactions with certain option counterparties with a strike price equal
to the conversion price of the notes. Upon conversion of the notes in June 2013,
we exercised the capped calls. The bulk of the capped calls were physically
settled by acquiring 29 million shares of our own common stock for $938 million.
The remaining capped calls were net cash settled for $24 million.

Credit Facility

In June 2013, we established a commercial paper program for the issuance and
sale of up to $1.3 billion in commercial paper. As of June 30, 2013, we have not
issued any commercial paper under this program.

In June 2013, we entered into a $1.3 billion credit facility, which will serve
as a back-up for our commercial paper program. As of June 30, 2013, we were in
compliance with the only financial covenant in the credit agreement, which
requires us to maintain a coverage ratio of at least three times earnings before
interest, taxes, depreciation, and amortization to interest expense, as defined
in the credit agreement. The credit facility expires on June 24, 2018. No
amounts were drawn against the credit facility since its inception.

Unearned Revenue

Unearned revenue at June 30, 2013 comprised mainly unearned revenue from volume
licensing programs. Unearned revenue from volume licensing programs represents
customer billings for multi-year licensing arrangements paid for either at
inception of the agreement or annually at the beginning of each coverage period
and accounted for as subscriptions with revenue recognized ratably over the
coverage period. Unearned revenue at June 30, 2013 also included payments for:
post-delivery support and consulting services to be performed in the future;
Xbox LIVE subscriptions and prepaid points; OEM minimum commitments; Microsoft
Dynamics business solutions products; Skype prepaid credits and subscriptions;
and other offerings for which we have been paid in advance and earn the revenue
when we provide the service or software, or otherwise meet the revenue
recognition criteria.

The following table outlines the expected future recognition of unearned revenue
as of June 30, 2013:

 

                         (In millions)                     
                         -------------------------------- -
                                              
                         Three Months Ending,              
                                              
                         September 30, 2013     $   7,790  
                         December 31, 2013          6,571  
                         March 31, 2014             4,252  
                         June 30, 2014              2,026  
                         Thereafter                 1,760  
                         -------------------------------- -
                         Total                  $  22,399  
                                                - ------- -


Share Repurchases

On September 22, 2008, we announced that our Board of Directors approved a new
share repurchase program authorizing up to $40.0 billion in share repurchases
with an expiration date of September 30, 2013. As of June 30, 2013,
approximately $3.6 billion remained of the $40.0 billion approved repurchase
amount. The repurchase program may be suspended or discontinued at any time
without notice.

 

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During the periods reported, we repurchased with cash resources: 158 million
shares for $4.6 billion during fiscal year 2013; 142 million shares for $4.0
billion during fiscal year 2012; and 447 million shares for $11.5 billion during
fiscal year 2011.

Dividends

During fiscal years 2013 and 2012, our Board of Directors declared the following
dividends:

 

                                 Dividend                                                                        
Declaration Date                Per Share              Record Date        Total Amount              Payment Date  
---------------------------------------------------------------------------------------------------------------- -
                                                                         (In millions)                            
                                                                                         
Fiscal Year 2013                                                                                                  
                                                                                         
September 18, 2012            $      0.23        November 15, 2012      $        1,933         December 13, 2012  
November 28, 2012             $      0.23        February 21, 2013      $        1,925            March 14, 2013  
March 11, 2013                $      0.23             May 16, 2013      $        1,921             June 13, 2013  
June 12, 2013                 $      0.23          August 15, 2013      $        1,916        September 12, 2013  
                                                                                         
Fiscal Year 2012                                                                                                  
                                                                                         
September 20, 2011            $      0.20        November 17, 2011      $        1,683          December 8, 2011  
December 14, 2011             $      0.20        February 16, 2012      $        1,683             March 8, 2012  
March 13, 2012                $      0.20             May 17, 2012      $        1,678             June 14, 2012  
June 13, 2012                 $      0.20          August 16, 2012      $        1,676        September 13, 2012  


--------------------------------------------------------------------------------
Off-Balance Sheet Arrangements

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

Contractual Obligations

The following table summarizes the payments due by fiscal year for our
outstanding contractual obligations as of June 30, 2013:

 

(In millions)                             2014       2015-2016       2017-2018       Thereafter         Total  
------------------------------------------------------------------------------------------------------------- -
                                                                                                  
Long-term debt: (a)                                                                                            
Principal payments                   $   3,000     $     2,500     $     1,050     $      9,115     $  15,665  
Interest payments                          459             776             693            4,940         6,868  
Construction commitments (b)               694               0               0                0           694  
Operating leases (c)                       572             800             485              605         2,462  
Purchase commitments (d)                13,752             934             258               83        15,027  
Other long-term liabilities (e)              0              67              20               23           110  
---------------------------------------------- -   -- -------- -   -- -------- -   -- --------- -   - ------- -
Total contractual obligations        $  18,477     $     5,077     $     2,506     $     14,766     $  40,826  
                                     - ------- -   -- -------- -   -- -------- -   -- --------- -   - ------- -


 

(a) See Note 12 – Debt of the Notes to Financial Statements (Part II, Item 8 of  
    this Form 10-K).                                                             


(b) These amounts represent commitments for the construction of buildings,       
    building improvements, and leasehold improvements.                           


(c) These amounts represent undiscounted future minimum rental commitments under 
    noncancellable facilities leases.                                            


(d) These amounts represent purchase commitments, including all open purchase    
    orders and all contracts that are take-or-pay contracts that are not         
    presented as construction commitments above.                                 


 

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(e) We have excluded long-term tax contingencies, other tax liabilities, and     
    deferred income taxes of $11.3 billion and other long-term contingent        
    liabilities of $162 million (related to the antitrust and unfair competition 
    class action lawsuits) from the amounts presented, as the amounts that will  
    be settled in cash are not known and the timing of any payments is uncertain.
    We have also excluded unearned revenue and non-cash items.                   


Other Planned Uses of Capital

We will continue to invest in sales, marketing, product support infrastructure,
and existing and advanced areas of technology. Additions to property and
equipment will continue, including new facilities, data centers, and computer
systems for research and development, sales and marketing, support, and
administrative staff. We expect capital expenditures to increase in coming years
in support of our cloud and devices strategy. We have operating leases for most
U.S. and international sales and support offices and certain equipment. We have
not engaged in any related party transactions or arrangements with
unconsolidated entities or other persons that are reasonably likely to
materially affect liquidity or the availability of capital resources.

Liquidity

We earn a significant amount of our operating income outside the U.S., which is
deemed to be permanently reinvested in foreign jurisdictions. As a result, as
discussed above under Cash, Cash Equivalents, and Investments, the majority of
our cash, cash equivalents, and short-term investments are held by foreign
subsidiaries. We currently do not intend nor foresee a need to repatriate these
funds. We expect existing domestic cash, cash equivalents, short-term
investments, and cash flows from operations to continue to be sufficient to fund
our domestic operating activities and cash commitments for investing and
financing activities, such as regular quarterly dividends, debt repayment
schedules, and material capital expenditures, for at least the next 12 months
and thereafter for the foreseeable future. In addition, we expect existing
foreign cash, cash equivalents, short-term investments, and cash flows from
operations to continue to be sufficient to fund our foreign operating activities
and cash commitments for investing activities, such as material capital
expenditures, for at least the next 12 months and thereafter for the foreseeable
future.

Should we require more capital in the U.S. than is generated by our operations
domestically, for example to fund significant discretionary activities, such as
business acquisitions and share repurchases, we could elect to repatriate future
earnings from foreign jurisdictions or raise capital in the U.S. through debt or
equity issuances. These alternatives could result in higher effective tax rates,
increased interest expense, or dilution of our earnings. We have borrowed funds
domestically and continue to believe we have the ability to do so at reasonable
interest rates.

                           RECENT ACCOUNTING GUIDANCE

Recently Adopted Accounting Guidance

In September 2011, the Financial Accounting Standards Board (“FASB”) issued
guidance on testing goodwill for impairment. The new guidance provides an entity
the option to first perform a qualitative assessment to determine whether it is
more likely than not that the fair value of a reporting unit is less than its
carrying amount. If an entity determines that this is the case, it is required
to perform the two-step goodwill impairment test to identify potential goodwill
impairment and measure the amount of goodwill impairment loss to be recognized
for that reporting unit (if any). If an entity determines that the fair value of
a reporting unit is greater than its carrying amount, the two-step goodwill
impairment test is not required. We adopted this new guidance beginning July 1,
2012. Adoption of this new guidance did not have a material impact on our
financial statements.

In June 2011, the FASB issued guidance on presentation of comprehensive
income. The new guidance eliminated the option to report other comprehensive
income (“OCI”) and its components in the statement of changes in stockholders’
equity. Instead, an entity is required to present either a continuous statement
of net income and OCI or in two separate but consecutive statements. We adopted
this new guidance beginning July 1, 2012. Adoption of this new guidance resulted
only in changes to presentation of our financial statements.

 

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Recent Accounting Guidance Not Yet Adopted

In December 2011, the FASB issued guidance enhancing disclosure requirements
about the nature of an entity’s right to offset and related arrangements
associated with its financial instruments and derivative instruments. The new
guidance requires the disclosure of the gross amounts subject to rights of
set-off, amounts offset in accordance with the accounting standards followed,
and the related net exposure. In January 2013, the FASB clarified that the scope
of this guidance applies to derivatives, including bifurcated embedded
derivatives, repurchase agreements and reverse repurchase agreements, and
securities borrowing and securities lending transactions that are either offset
or subject to an enforceable master netting arrangement, or similar agreements.
The new guidance will be effective for us beginning July 1, 2013. Other than
requiring additional disclosures, we do not anticipate material impacts on our
financial statements upon adoption.

In February 2013, the FASB issued guidance on disclosure requirements for items
reclassified out of accumulated other comprehensive income (“AOCI”). This new
guidance requires entities to present (either on the face of the income
statement or in the notes) the effects on the line items of the income statement
for amounts reclassified out of AOCI. The new guidance will be effective for us
beginning July 1, 2013. Other than requiring additional disclosures, we do not
anticipate material impacts on our financial statements upon adoption.

In March 2013, the FASB issued guidance on a parent’s accounting for the
cumulative translation adjustment upon derecognition of a subsidiary or group of
assets within a foreign entity. This new guidance requires that the parent
release any related cumulative translation adjustment into net income only if
the sale or transfer results in the complete or substantially complete
liquidation of the foreign entity in which the subsidiary or group of assets had
resided. The new guidance will be effective for us beginning July 1, 2014. We do
not anticipate material impacts on our financial statements upon adoption.

                  APPLICATION OF CRITICAL ACCOUNTING POLICIES

Our financial statements and accompanying notes are prepared in accordance with
U.S. GAAP. Preparing 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

Revenue recognition requires judgment, including whether a software arrangement
includes multiple elements, and if so, whether the vendor-specific objective
evidence (“VSOE”) of fair value exists for those elements. A portion of revenue
may be recorded as unearned due to undelivered elements. Changes to the elements
in a software arrangement, the ability to identify the VSOE for those elements,
and the fair value of the respective elements could materially impact the amount
of earned and unearned revenue. Judgment is also required to assess whether
future releases of certain software represent new products or upgrades and
enhancements to existing products. Certain volume licensing arrangements include
a perpetual license for current products combined with rights to receive
unspecified future versions of software products (“Software Assurance”) and are
accounted for as subscriptions, with billings recorded as unearned revenue and
recognized as revenue ratably over the coverage period.

Software updates are evaluated on a case-by-case basis to determine whether they
meet the definition of an upgrade, which may require revenue to be deferred and
recognized when the upgrade is delivered, or if it is determined that implied
post-contract customer support (“PCS”) is being provided, revenue from the
arrangement is deferred and recognized over the implied PCS term. If updates are
determined to not meet the definition of an upgrade, revenue is generally
recognized as products are shipped or made available.

Windows 8.1 will enable new hardware, further the integration with other
Microsoft services and address customer issues with Windows 8, and will be
provided to Windows 8 customers when available at no additional charge. We
evaluated Windows 8.1 and determined that it did not meet the definition of an
upgrade and thus have not deferred revenue related to this planned release.

 

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Windows 7 revenue was subject to deferral as a result of the Windows Upgrade
Offer, which started June 2, 2012. The offer provided significantly discounted
rights to purchase Windows 8 Pro to qualifying end-users that purchased Windows
7 PCs during the eligibility period. Microsoft was responsible for delivering
Windows 8 Pro to the end customer. Accordingly, revenue related to the allocated
discount for undelivered Windows 8 was deferred until it was delivered or the
redemption period expired.

Microsoft Office system revenue was subject to deferral as a result of the
Office Upgrade Offer, which started October 19, 2012. The Office Upgrade Offer
allowed customers who purchased qualifying 2010 Microsoft Office system or
Office for Mac 2011 products to receive, at no cost, a one-year subscription to
Office 365 Home Premium or the equivalent version of 2013 Microsoft Office
system upon general availability. Small business customers in applicable markets
were also eligible for a three-month trial of Office 365 Small Business Premium.
Accordingly, estimated revenue related to the undelivered 2013 Microsoft Office
system and subscription services was deferred until the products and services
were delivered or the redemption period expired.

Impairment of Investment Securities

We review investments quarterly for indicators of other-than-temporary
impairment. This determination requires significant judgment. In making this
judgment, we employ a systematic methodology quarterly that considers available
quantitative and qualitative evidence in evaluating potential impairment of our
investments. If the cost of an investment exceeds its fair value, we evaluate,
among other factors, general market conditions, credit quality of debt
instrument issuers, the duration and extent to which the fair value is less than
cost, and for equity securities, our intent and ability to hold, or plans to
sell, the investment. For fixed-income securities, we also evaluate whether we
have plans to sell the security or it is more likely than not that we will be
required to sell the security before recovery. We also consider specific adverse
conditions related to the financial health of and business outlook for the
investee, including industry and sector performance, changes in technology, and
operational and financing cash flow factors. Once a decline in fair value is
determined to be other-than-temporary, an impairment charge is recorded to other
income (expense) and a new cost basis in the investment is established. If
market, industry, and/or investee conditions deteriorate, we may incur future
impairments.

Goodwill

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

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

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

Research and Development Costs

Costs incurred internally in researching and developing a computer software
product are charged to expense until technological feasibility has been
established for the product. Once technological feasibility is established, all

 

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

Legal and Other Contingencies

The outcomes of legal proceedings and claims brought against us are subject to
significant uncertainty. An estimated loss from a loss contingency such as a
legal proceeding or claim is accrued by a charge to income if it is probable
that an asset has been impaired or a liability has been incurred and the amount
of the loss can be reasonably estimated. Disclosure of a contingency is required
if there is at least a reasonable possibility that a loss has been incurred. 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 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 current and deferred income
tax assets and liabilities, accounting for interest and penalties associated
with tax positions, and income tax disclosures. Judgment is required in
assessing the future tax consequences of events that have been recognized in our
financial statements or tax returns. Variations in the actual outcome of these
future tax consequences could materially impact our financial statements.

Inventories

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

 

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STATEMENT OF MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL STATEMENTS

Management is responsible for the preparation of the consolidated financial
statements and related information that are presented in this report. The
consolidated financial statements, which include amounts based on management’s
estimates and judgments, have been prepared in conformity with accounting
principles generally accepted in the United States of America.

The Company designs and maintains accounting and internal control systems to
provide reasonable assurance at reasonable cost that assets are safeguarded
against loss from unauthorized use or disposition, and that the financial
records are reliable for preparing financial statements and maintaining
accountability for assets. These systems are augmented by written policies, an
organizational structure providing division of responsibilities, careful
selection and training of qualified personnel, and a program of internal audits.

The Company engaged Deloitte & Touche LLP, an independent registered public
accounting firm, to audit and render an opinion on the consolidated financial
statements and internal control over financial reporting in accordance with the
standards of the Public Company Accounting Oversight Board (United States).

The Board of Directors, through its Audit Committee, consisting solely of
independent directors of the Company, meets periodically with management,
internal auditors, and our independent registered public accounting firm to
ensure that each is meeting its responsibilities and to discuss matters
concerning internal controls and financial reporting. Deloitte & Touche LLP and
the internal auditors each have full and free access to the Audit Committee.

Steven A. Ballmer                                    
Chief Executive Officer                              

Amy E. Hood                                          
Executive Vice President and Chief Financial Officer 

Frank H. Brod                                        
Corporate Vice President, Finance and Administration;
Chief Accounting Officer                             


 

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      ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

                                     RISKS

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

Foreign Currency

Certain forecasted transactions, assets, and liabilities are exposed to foreign
currency risk. We monitor our foreign currency exposures daily and use hedges
where practicable to offset the risks and maximize the economic effectiveness of
our foreign currency positions. Principal currencies hedged include the euro,
Japanese yen, British pound, and Canadian dollar.

Interest Rate

Our fixed-income portfolio is diversified across credit sectors and maturities,
consisting primarily of investment-grade securities. The credit risk and average
maturity of the fixed-income portfolio is managed to achieve economic returns
that correlate to certain global and domestic fixed-income indices. In addition,
we use “To Be Announced” forward purchase commitments of mortgage-backed assets
to gain exposure to agency and mortgage-backed securities.

Equity

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

Commodity

We use broad-based commodity exposures to enhance portfolio returns and
facilitate portfolio diversification. Our investment portfolio has exposure to a
variety of commodities, including precious metals, energy, and grain. We manage
these exposures relative to global commodity indices and expect their economic
risk and return to correlate with these indices.

                                 VALUE-AT-RISK

We use a value-at-risk (“VaR”) model to estimate and quantify our market risks.
VaR is the expected loss, for a given confidence level, in the fair value of our
portfolio due to adverse market movements over a defined time horizon. The VaR
model is not intended to represent actual losses in fair value, including
determinations of other-than-temporary losses in fair value in accordance with
accounting principles generally accepted in the United States (“U.S. GAAP”), but
is used as a risk estimation and management tool. The distribution of the
potential changes in total market value of all holdings is computed based on the
historical volatilities and correlations among foreign currency exchange rates,
interest rates, equity prices, and commodity prices, assuming normal market
conditions.

The VaR is calculated as the total loss that will not be exceeded at the 97.5
percentile confidence level or, alternatively stated, the losses could exceed
the VaR in 25 out of 1,000 cases. Several risk factors are not captured in the
model, including liquidity risk, operational risk, and legal risk.

 

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The following table sets forth the one-day VaR for substantially all of our
positions as of June 30, 2013 and 2012 and for the year ended June 30, 2013:

 

         (In millions)                                                                     
         -------------------------------------------------------------------------------- -
                                                        
                              June 30,       June 30,                 Year Ended June 30, 
                                  2013           2012                                2013  
                                                          -- ---------------------------- -
         Risk Categories                                    Average       High        Low  
                                                                                 
         Foreign currency   $      199     $       98     $     215     $  256     $   90  
         Interest rate      $       85     $       71     $      73     $   86     $   63  
         Equity             $      181     $      205     $     198     $  211     $  178  
         Commodity          $       19     $       18     $      20     $   24     $   18  


--------------------------------------------------------------------------------
Total one-day VaR for the combined risk categories was $350 million at June 30,
2013 and $292 million at June 30, 2012. The total VaR is 28% less at June 30,
2013, and 26% less at June 30, 2012, than the sum of the separate risk
categories in the above table due to the diversification benefit of the
combination of risks.

 

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              ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                               INCOME STATEMENTS

 

     (In millions, except per share amounts)                                           
     -------------------------------------------------------------------------------- -
                                                                          
     Year Ended June 30,                             2013          2012          2011  
                                                                          
     Revenue                                    $  77,849     $  73,723     $  69,943  
     Cost of revenue                               20,249        17,530        15,577  
     ---------------------------------------------------- -   - ------- -   - ------- -
     Gross profit                                  57,600        56,193        54,366  
     Operating expenses:                                                               
     Research and development                      10,411         9,811         9,043  
     Sales and marketing                           15,276        13,857        13,940  
     General and administrative                     5,149         4,569         4,222  
     Goodwill impairment                                0         6,193             0  
     ---------------------------------------------------- -   - ------- -   - ------- -
     Total operating expenses                      30,836        34,430        27,205  
     ---------------------------------------------------- -   - ------- -   - ------- -
     Operating income                              26,764        21,763        27,161  
     Other income                                     288           504           910  
     ---------------------------------------------------- -   - ------- -   - ------- -
     Income before income taxes                    27,052        22,267        28,071  
     Provision for income taxes                     5,189         5,289         4,921  
     ---------------------------------------------------- -   - ------- -   - ------- -
     Net income                                 $  21,863     $  16,978     $  23,150  
                                                - ------- -   - ------- -   - ------- -
                                                                          
     Earnings per share:                                                               
     Basic                                      $    2.61     $    2.02     $    2.73  
     Diluted                                    $    2.58     $    2.00     $    2.69  
                                                                          
     Weighted average shares outstanding:                                              
     Basic                                          8,375         8,396         8,490  
     Diluted                                        8,470         8,506         8,593  
                                                                          
     Cash dividends declared per common share   $    0.92     $    0.80     $    0.64  


--------------------------------------------------------------------------------
See accompanying notes.

 

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                        COMPREHENSIVE INCOME STATEMENTS

 

(In millions)                                                                                      
------------------------------------------------------------------------------------------------ --
                                                                                    
Year Ended June 30,                                         2013            2012            2011   
                                                                                    
Net income                                             $  21,863       $  16,978       $  23,150   
Other comprehensive income (loss):                                                                 
Net unrealized gains (losses) on derivatives (net                                                
of tax effects of $(14), $137, and $(338))                   (26 )           255            (627 ) 
Net unrealized gains (losses) on investments (net                                                
of tax effects of $195, $(210), and $567)                    363            (390 )         1,054   
Translation adjustments and other (net of tax                                                    
effects of $(8), $(165), and $205)                           (16 )          (306 )           381   
---------------------------------------------------------------- --    - ------- --    - ------- --
Other comprehensive income (loss)                            321            (441 )           808   
---------------------------------------------------------------- --    - ------- --    - ------- --
Comprehensive income                                   $  22,184       $  16,537       $  23,958   
---------------------------------------------------------------- --    - ------- --    - ------- --


See accompanying notes.

 

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                                 BALANCE SHEETS

 

(In millions)                                                                               
----------------------------------------------------------------------------------------- --
                                                                            
June 30,                                                             2013            2012   
                                                                            
Assets                                                                                      
Current assets:                                                                             
Cash and cash equivalents                                      $    3,804      $    6,938   
Short-term investments (including securities loaned of $579                               
and $785)                                                          73,218          56,102   
------------------------------------------------------------------------- -    - -------- --
Total cash, cash equivalents, and short-term investments           77,022          63,040   
Accounts receivable, net of allowance for doubtful accounts                               
of $336 and $389                                                   17,486          15,780   
Inventories                                                         1,938           1,137   
Deferred income taxes                                               1,632           2,035   
Other                                                               3,388           3,092   
------------------------------------------------------------------------- -    - -------- --
Total current assets                                              101,466          85,084   
Property and equipment, net of accumulated depreciation of                                
$12,513 and $10,962                                                 9,991           8,269   
Equity and other investments                                       10,844           9,776   
Goodwill                                                           14,655          13,452   
Intangible assets, net                                              3,083           3,170   
Other long-term assets                                              2,392           1,520   
------------------------------------------------------------------------- -    - -------- --
Total assets                                                   $  142,431      $  121,271   
                                                               - -------- -    - -------- --
Liabilities and stockholders’ equity                                                        
Current liabilities:                                                                        
Accounts payable                                               $    4,828      $    4,175   
Current portion of long-term debt                                   2,999           1,231   
Accrued compensation                                                4,117           3,875   
Income taxes                                                          592             789   
Short-term unearned revenue                                        20,639          18,653   
Securities lending payable                                            645             814   
Other                                                               3,597           3,151   
------------------------------------------------------------------------- -    - -------- --
Total current liabilities                                          37,417          32,688   
Long-term debt                                                     12,601          10,713   
Long-term unearned revenue                                          1,760           1,406   
Deferred income taxes                                               1,709           1,893   
Other long-term liabilities                                        10,000           8,208   
------------------------------------------------------------------------- -    - -------- --
Total liabilities                                                  63,487          54,908   
------------------------------------------------------------------------- -    - -------- --
Commitments and contingencies                                                               
Stockholders’ equity:                                                                       
Common stock and paid-in capital – shares authorized                                      
24,000; outstanding 8,328 and 8,381                                67,306          65,797   
Retained earnings (deficit)                                         9,895            (856 ) 
Accumulated other comprehensive income                              1,743           1,422   
------------------------------------------------------------------------- -    - -------- --
Total stockholders’ equity                                         78,944          66,363   
------------------------------------------------------------------------- -    - -------- --
Total liabilities and stockholders’ equity                     $  142,431      $  121,271   
                                                               - -------- -    - -------- --


See accompanying notes.

 

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                             CASH FLOWS STATEMENTS

 

(In millions)                                                                                       
------------------------------------------------------------------------------------------------- --
                                                                                    
Year Ended June 30,                                        2013             2012             2011   
                                                                                    
Operations                                                                                          
Net income                                           $   21,863       $   16,978       $   23,150   
Adjustments to reconcile net income to net cash                                                   
from operations:                                                                                    
Goodwill impairment                                           0            6,193                0   
Depreciation, amortization, and other                     3,755            2,967            2,766   
Stock-based compensation expense                          2,406            2,244            2,166   
Net recognized losses (gains) on investments and                                                  
derivatives                                                  80             (200 )           (362 ) 
Excess tax benefits from stock-based compensation          (209 )            (93 )            (17 ) 
Deferred income taxes                                       (19 )            954                2   
Deferral of unearned revenue                             44,253           36,104           31,227   
Recognition of unearned revenue                         (41,921 )        (33,347 )        (28,935 ) 
Changes in operating assets and liabilities:                                                        
Accounts receivable                                      (1,807 )         (1,156 )         (1,451 ) 
Inventories                                                (802 )            184             (561 ) 
Other current assets                                       (129 )            493           (1,259 ) 
Other long-term assets                                     (478 )           (248 )             62   
Accounts payable                                            537              (31 )             58   
Other current liabilities                                   146              410           (1,146 ) 
Other long-term liabilities                               1,158              174            1,294   
--------------------------------------------------------------- --    - -------- --    - -------- --
Net cash from operations                                 28,833           31,626           26,994   
--------------------------------------------------------------- --    - -------- --    - -------- --
Financing                                                                                           
Short-term debt repayments, maturities of 90 days                                                 
or less, net                                                  0                0             (186 ) 
Proceeds from issuance of debt                            4,883                0            6,960   
Repayments of debt                                       (1,346 )              0             (814 ) 
Common stock issued                                         931            1,913            2,422   
Common stock repurchased                                 (5,360 )         (5,029 )        (11,555 ) 
Common stock cash dividends paid                         (7,455 )         (6,385 )         (5,180 ) 
Excess tax benefits from stock-based compensation           209               93               17   
Other                                                       (10 )              0              (40 ) 
--------------------------------------------------------------- --    - -------- --    - -------- --
Net cash used in financing                               (8,148 )         (9,408 )         (8,376 ) 
--------------------------------------------------------------- --    - -------- --    - -------- --
Investing                                                                                           
Additions to property and equipment                      (4,257 )         (2,305 )         (2,355 ) 
Acquisition of companies, net of cash acquired,                                                   
and purchases of intangible and other assets             (1,584 )        (10,112 )            (71 ) 
Purchases of investments                                (75,396 )        (57,250 )        (35,993 ) 
Maturities of investments                                 5,130           15,575            6,897   
Sales of investments                                     52,464           29,700           15,880   
Securities lending payable                                 (168 )           (394 )          1,026   
--------------------------------------------------------------- --    - -------- --    - -------- --
Net cash used in investing                              (23,811 )        (24,786 )        (14,616 ) 
--------------------------------------------------------------- --    - -------- --    - -------- --
Effect of exchange rates on cash and cash                                                         
equivalents                                                  (8 )           (104 )            103   
--------------------------------------------------------------- --    - -------- --    - -------- --
Net change in cash and cash equivalents                  (3,134 )         (2,672 )          4,105   
Cash and cash equivalents, beginning of period            6,938            9,610            5,505   
--------------------------------------------------------------- --    - -------- --    - -------- --
Cash and cash equivalents, end of period             $    3,804       $    6,938       $    9,610   
                                                     - -------- --    - -------- --    - -------- --


See accompanying notes.

 

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                        STOCKHOLDERS’ EQUITY STATEMENTS

 

(In millions)                                                                                       
------------------------------------------------------------------------------------------------- --
                                                                                    
Year Ended June 30,                                        2013             2012             2011   
                                                                                    
Common stock and paid-in capital                                                                    
Balance, beginning of period                         $   65,797       $   63,415       $   62,856   
Common stock issued                                         920            1,924            2,422   
Common stock repurchased                                 (2,014 )         (1,714 )         (3,738 ) 
Stock-based compensation expense                          2,406            2,244            2,166   
Stock-based compensation income tax benefits                                                      
(deficiencies)                                              190              (75 )           (292 ) 
Other, net                                                    7                3                1   
--------------------------------------------------------------- --    - -------- --    - -------- --
Balance, end of period                                   67,306           65,797           63,415   
--------------------------------------------------------------- --    - -------- --    - -------- --
Retained earnings (deficit)                                                                         
Balance, beginning of period                               (856 )         (8,195 )        (17,736 ) 
Net income                                               21,863           16,978           23,150   
Common stock cash dividends                              (7,694 )         (6,721 )         (5,394 ) 
Common stock repurchased                                 (3,418 )         (2,918 )         (8,215 ) 
--------------------------------------------------------------- --    - -------- --    - -------- --
Balance, end of period                                    9,895             (856 )         (8,195 ) 
--------------------------------------------------------------- --    - -------- --    - -------- --
Accumulated other comprehensive income                                                              
Balance, beginning of period                              1,422            1,863            1,055   
Other comprehensive income (loss)                           321             (441 )            808   
--------------------------------------------------------------- --    - -------- --    - -------- --
Balance, end of period                                    1,743            1,422            1,863   
--------------------------------------------------------------- --    - -------- --    - -------- --
Total stockholders’ equity                           $   78,944       $   66,363       $   57,083   
                                                     - -------- --    - -------- --    - -------- --


See accompanying notes.

 

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                         NOTES TO FINANCIAL STATEMENTS

                          NOTE 1 — ACCOUNTING POLICIES

Accounting Principles

The financial statements and accompanying notes are prepared in accordance with
accounting principles generally accepted in the United States of America (“U.S.
GAAP”).

Principles of Consolidation

The financial statements include the accounts of Microsoft Corporation and its
subsidiaries. Intercompany transactions and balances have been eliminated.
Equity investments through which we exercise significant influence over but do
not control the investee and are not the primary beneficiary of the investee’s
activities are accounted for using the equity method. Investments through which
we are not able to exercise significant influence over the investee and which do
not have readily determinable fair values are accounted for under the cost
method.

Estimates and Assumptions

Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue,
and expenses. Examples of estimates include: loss contingencies; product
warranties; the fair value of, and/or potential goodwill impairment for, our
reporting units; product life cycles; useful lives of our tangible and
intangible assets; allowances for doubtful accounts; allowances for product
returns; the market value of our inventory; and stock-based compensation
forfeiture rates. Examples of assumptions include: the elements comprising a
software arrangement, including the distinction between upgrades or enhancements
and new products; when technological feasibility is achieved for our products;
the potential outcome of future tax consequences of events that have been
recognized in our financial statements or tax returns; and determining when
investment impairments are other-than-temporary. Actual results and outcomes may
differ from management’s estimates and assumptions.

Foreign Currencies

Assets and liabilities recorded in foreign currencies are translated at the
exchange rate on the balance sheet date. Revenue and expenses are translated at
average rates of exchange prevailing during the year. Translation adjustments
resulting from this process are recorded to other comprehensive income (“OCI”).

Revenue Recognition

Revenue is recognized when persuasive evidence of an arrangement exists,
delivery has occurred, the fee is fixed or determinable, and collectibility is
probable. Revenue generally is recognized net of allowances for returns and any
taxes collected from customers and subsequently remitted to governmental
authorities.

Revenue for retail packaged products, products licensed to original equipment
manufacturers (“OEMs”), and perpetual licenses under certain volume licensing
programs generally is recognized as products are shipped or made available.

Technology guarantee programs are accounted for as multiple element arrangements
as customers receive free or significantly discounted rights to use upcoming new
versions of a software product if they license existing versions of the product
during the eligibility period. Revenue is allocated between the existing product
and the new product, and revenue allocated to the new product is deferred until
that version is delivered. The revenue allocation is based on the
vendor-specific objective evidence (“VSOE”) of fair value of the products. The
VSOE of fair value for upcoming new products are based on the price determined
by management having the relevant authority when the element is not yet sold
separately, but is expected to be sold in the near future at the price set by
management.

 

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Software updates that will be provided free of charge are evaluated on a
case-by-case basis to determine whether they meet the definition of an upgrade
and create a multiple element arrangement, which may require revenue to be
deferred and recognized when the upgrade is delivered, or if it is determined
that implied post-contract customer support (“PCS”) is being provided, the
arrangement is accounted for as a multiple element arrangement and all revenue
from the arrangement is deferred and recognized over the implied PCS term when
the VSOE of fair value does not exist. If updates are determined to not meet the
definition of an upgrade, revenue is generally recognized as products are
shipped or made available. Windows 8.1 will enable new hardware, further the
integration with other Microsoft services and fix some of the customer issues
with Windows 8, and will be provided to Windows 8 customers when available at no
additional charge. We evaluated Windows 8.1 and determined that it did not meet
the definition of an upgrade and thus have not deferred revenue related to this
planned release.

Certain volume licensing arrangements include a perpetual license for current
products combined with rights to receive unspecified future versions of software
products (“Software Assurance”), which we have determined are additional
software products and are therefore accounted for as subscriptions, with
billings recorded as unearned revenue and recognized as revenue ratably over the
coverage period. Arrangements that include term based licenses for current
products with the right to use unspecified future versions of the software
during the coverage period, are also accounted for as subscriptions, with
revenue recognized ratably over the coverage period.

Revenue from cloud-based services arrangements that allow for the use of a
hosted software product or service over a contractually determined period of
time without taking possession of software are accounted for as subscriptions
with billings recorded as unearned revenue and recognized as revenue ratably
over the coverage period beginning on the date the service is made available to
customers. Revenue from cloud-based services arrangements that are provided on a
consumption basis (for example, the amount of storage used in a particular
period) is recognized commensurate with the customer utilization of such
resources.

Some volume licensing arrangements include time-based subscriptions for
cloud-based services and software offerings that are accounted for as
subscriptions. These arrangements are considered multiple element arrangements.
However, because all elements are accounted for as subscriptions and have the
same coverage period and delivery pattern, they have the same revenue
recognition timing.

Revenue related to Surface, our Xbox 360 gaming and entertainment console,
Kinect for Xbox 360, games published by us, and other hardware components is
generally recognized when ownership is transferred to the resellers or end
customers when selling directly through Microsoft Stores. Revenue related to
games published by third parties for use on the Xbox 360 platform is recognized
when games are manufactured by the game publishers.

Display advertising revenue is recognized as advertisements are displayed.
Search advertising revenue is recognized when the ad appears in the search
results or when the action necessary to earn the revenue has been completed.
Consulting services revenue is recognized as services are rendered, generally
based on the negotiated hourly rate in the consulting arrangement and the number
of hours worked during the period. Consulting revenue for fixed-price services
arrangements is recognized as services are provided. Revenue from prepaid points
redeemable for the purchase of software or services is recognized upon
redemption of the points and delivery of the software or services.

Cost of Revenue

Cost of revenue includes: manufacturing and distribution costs for products sold
and programs licensed; operating costs related to product support service
centers and product distribution centers; costs incurred to include software on
PCs sold by OEMs, to drive traffic to our websites, and to acquire online
advertising space (“traffic acquisition costs”); costs incurred to support and
maintain Internet-based products and services, including datacenter costs and
royalties; warranty costs; inventory valuation adjustments; costs associated
with the delivery of consulting services; and the amortization of capitalized
research and development costs. Capitalized research and development costs are
amortized over the estimated lives of the products.

 

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Product Warranty

We provide for the estimated costs of fulfilling our obligations under hardware
and software warranties at the time the related revenue is recognized. For
hardware warranties, we estimate the costs based on historical and projected
product failure rates, historical and projected repair costs, and knowledge of
specific product failures (if any). The specific hardware warranty terms and
conditions vary depending upon the product sold and the country in which we do
business, but generally include parts and labor over a period generally ranging
from 90 days to three years. For software warranties, we estimate the costs to
provide bug fixes, such as security patches, over the estimated life of the
software. We regularly reevaluate our estimates to assess the adequacy of the
recorded warranty liabilities and adjust the amounts as necessary.

Research and Development

Research and development expenses include payroll, employee benefits,
stock-based compensation expense, and other headcount-related expenses
associated with product development. Research and development expenses also
include third-party development and programming costs, localization costs
incurred to translate software for international markets, and the amortization
of purchased software code and services content. Such costs related to software
development are included in research and development expense until the point
that technological feasibility is reached, which for our software products, is
generally shortly before the products are released to manufacturing. Once
technological feasibility is reached, such costs are capitalized and amortized
to cost of revenue over the estimated lives of the products.

Sales and Marketing

Sales and marketing expenses include payroll, employee benefits, stock-based
compensation expense, and other headcount-related expenses associated with sales
and marketing personnel, and the costs of advertising, promotions, trade shows,
seminars, and other programs. Advertising costs are expensed as incurred.
Advertising expense was $2.6 billion, $1.6 billion, and $1.9 billion in fiscal
years 2013, 2012, and 2011, respectively.

Stock-Based Compensation

We measure stock-based compensation cost at the grant date based on the fair
value of the award and recognize it as expense, net of estimated forfeitures,
over the vesting or service period, as applicable, of the stock award (generally
four to five years) using the straight-line method.

Employee Stock Purchase Plan

Shares of our common stock may be purchased by employees at three-month
intervals at 90% of the fair market value of the stock on the last day of each
three-month period. Compensation expense for the employee stock purchase plan is
measured as the discount the employee is entitled to upon purchase and is
recognized in the period of purchase.

Income Taxes

Income tax expense includes U.S. and international income taxes, the provision
for U.S. taxes on undistributed earnings of international subsidiaries not
deemed to be permanently invested, and interest and penalties on uncertain tax
positions. Certain income and expenses are not reported in tax returns and
financial statements in the same year. The tax effect of such temporary
differences is reported as deferred income taxes. Deferred tax assets are
reported net of a valuation allowance when it is more likely than not that a tax
benefit will not be realized. The deferred income taxes are classified as
current or long-term based on the classification of the related asset or
liability.

 

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Fair Value Measurements

We account for certain assets and liabilities at fair value. The hierarchy below
lists three levels of fair value based on the extent to which inputs used in
measuring fair value are observable in the market. We categorize each of our
fair value measurements in one of these three levels based on the lowest level
input that is significant to the fair value measurement in its entirety. These
levels are:

 

     •   Level 1 – inputs are based upon unadjusted quoted prices for identical    
         instruments traded in active markets. Our Level 1 non-derivative          
         investments primarily include U.S. government securities, domestic and    
         international equities, and actively traded mutual funds. Our Level 1     
         derivative assets and liabilities include those actively traded on        
         exchanges.                                                                


 

     •   Level 2 – inputs are based upon quoted prices for similar instruments in  
         active markets, quoted prices for identical or similar instruments in     
         markets that are not active, and model-based valuation techniques (e.g.   
         the Black-Scholes model) for which all significant inputs are observable  
         in the market or can be corroborated by observable market data for        
         substantially the full term of the assets or liabilities. Where           
         applicable, these models project future cash flows and discount the future
         amounts to a present value using market-based observable inputs including 
         interest rate curves, credit spreads, foreign exchange rates, and forward 
         and spot prices for currencies and commodities. Our Level 2 non-derivative
         investments consist primarily of corporate notes and bonds,               
         mortgage-backed securities, U.S. agency securities, certificates of       
         deposit, and foreign government bonds. Our Level 2 derivative assets and  
         liabilities primarily include certain over-the-counter option and swap    
         contracts.                                                                


 

     •   Level 3 – inputs are generally unobservable and typically reflect         
         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 primarily comprise    
         investments in certain corporate bonds and goodwill when it is recorded at
         fair value due to an impairment charge. We value the Level 3 corporate    
         bonds using internally developed valuation models, inputs to which include
         interest rate curves, credit spreads, stock prices, and volatilities. In  
         certain cases, market-based observable inputs are not available and we use
         management judgment to develop assumptions to determine fair value for    
         these derivatives. Unobservable inputs used in all of these models are    
         significant to the fair values of the assets and liabilities.             


We measure certain assets, including our cost and equity method investments, at
fair value on a nonrecurring basis when they are deemed to be
other-than-temporarily impaired. The fair values of these investments are
determined based on valuation techniques using the best information available,
and may include quoted market prices, market comparables, and discounted cash
flow projections. An impairment charge is recorded when the cost of the
investment exceeds its fair value and this condition is determined to be
other-than-temporary.

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

Financial Instruments

We consider all highly liquid interest-earning investments with a maturity of
three months or less at the date of purchase to be cash equivalents. The fair
values of these investments approximate their carrying values. In general,
investments with original maturities of greater than three months and remaining
maturities of less than one year are classified as short-term investments.
Investments with maturities beyond one year may be classified as short-term
based on their highly liquid nature and because such marketable securities
represent the investment of cash that is available for current operations. All
cash equivalents and short-term investments are classified as available-for-sale
and realized gains and losses are recorded using the specific identification
method. Changes in market value, excluding other-than-temporary impairments, are
reflected in OCI.

Equity and other investments classified as long-term include both debt and
equity instruments. Debt and publicly-traded equity securities are classified as
available-for-sale and realized gains and losses are recorded using the

 

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specific identification method. Changes in market value, excluding
other-than-temporary impairments, are reflected in OCI. Common and preferred
stock and other investments that are restricted for more than one year or are
not publicly traded are recorded at cost or using the equity method.

We lend certain fixed-income and equity securities to increase investment
returns. The loaned securities continue to be carried as investments on our
balance sheet. Cash and/or security interests are received as collateral for the
loaned securities with the amount determined based upon the underlying security
lent and the creditworthiness of the borrower. Cash received is recorded as an
asset with a corresponding liability.

Investments are considered to be impaired when a decline in fair value is judged
to be other-than-temporary. Fair value is calculated based on publicly available
market information or other estimates determined by management. We employ a
systematic methodology on a quarterly basis that considers available
quantitative and qualitative evidence in evaluating potential impairment of our
investments. If the cost of an investment exceeds its fair value, we evaluate,
among other factors, general market conditions, credit quality of debt
instrument issuers, the duration and extent to which the fair value is less than
cost, and for equity securities, our intent and ability to hold, or plans to
sell, the investment. For fixed-income securities, we also evaluate whether we
have plans to sell the security or it is more likely than not that we will be
required to sell the security before recovery. We also consider specific adverse
conditions related to the financial health of and business outlook for the
investee, including industry and sector performance, changes in technology, and
operational and financing cash flow factors. Once a decline in fair value is
determined to be other-than-temporary, an impairment charge is recorded to other
income (expense) and a new cost basis in the investment is established.

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

For derivative instruments designated as fair-value hedges, the gains (losses)
are recognized in earnings in the periods of change together with the offsetting
losses (gains) on the hedged items attributed to the risk being hedged. For
options designated as fair-value hedges, changes in the time value are excluded
from the assessment of hedge effectiveness and are recognized in earnings.

For derivative instruments designated as cash-flow hedges, the effective portion
of the gains (losses) on the derivatives is initially reported as a component of
OCI and is subsequently recognized in earnings when the hedged exposure is
recognized in earnings. For options designated as cash-flow hedges, changes in
the time value are excluded from the assessment of hedge effectiveness and are
recognized in earnings. Gains (losses) on derivatives representing either hedge
components excluded from the assessment of effectiveness or hedge
ineffectiveness are recognized in earnings.

For derivative instruments that are not designated as hedges, gains (losses)
from changes in fair values are primarily recognized in other income (expense).
Other than those derivatives entered into for investment purposes, such as
commodity contracts, the gains (losses) are generally economically offset by
unrealized gains (losses) in the underlying available-for-sale securities, which
are recorded as a component of OCI until the securities are sold or
other-than-temporarily impaired, at which time the amounts are reclassified from
accumulated other comprehensive income (“AOCI”) into other income (expense).

 

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Allowance for Doubtful Accounts

The allowance for doubtful accounts reflects our best estimate of probable
losses inherent in the accounts receivable balance. We determine the allowance
based on known troubled accounts, historical experience, and other currently
available evidence. Activity in the allowance for doubtful accounts was as
follows:

 

              (In millions)                                                   
              ------------------------------------------------------------- --
                                                                   
              Year Ended June 30,              2013        2012        2011   
                                                                   
              Balance, beginning of period   $  389      $  333      $  375   
              Charged to costs and other          4         115          14   
              Write-offs                        (57 )       (59 )       (56 ) 
              ------------------------------------- --   - ---- --   - ---- --
              Balance, end of period         $  336      $  389      $  333   
                                             - ---- --   - ---- --   - ---- --


Inventories

Inventories are stated at average cost, subject to the lower of cost or market.
Cost includes materials, labor, and manufacturing overhead related to the
purchase and production of inventories. We regularly review inventory quantities
on hand, future purchase commitments with our suppliers, and the estimated
utility of our inventory. If our review indicates a reduction in utility below
carrying value, we reduce our inventory to a new cost basis through a charge to
cost of revenue.

Property and Equipment

Property and equipment is stated at cost and depreciated using the straight-line
method over the shorter of the estimated useful life of the asset or the lease
term. The estimated useful lives of our property and equipment are generally as
follows: computer software developed or acquired for internal use, three years;
computer equipment, two to three years; buildings and improvements, five to 15
years; leasehold improvements, two to 10 years; and furniture and equipment, one
to five years. Land is not depreciated.

Goodwill

Goodwill is tested for impairment at the reporting unit level (operating segment
or one level below an operating segment) on an annual basis (May 1 for us) and
between annual tests if an event occurs or circumstances change that would more
likely than not reduce the fair value of a reporting unit below its carrying
value.

Intangible Assets

All of our intangible assets are subject to amortization and are amortized using
the straight-line method over their estimated period of benefit, ranging from
one to 15 years. We evaluate the recoverability of intangible assets
periodically by taking into account events or circumstances that may warrant
revised estimates of useful lives or that indicate the asset may be impaired.

Recent Accounting Guidance

Recently adopted accounting guidance

In September 2011, the Financial Accounting Standards Board (“FASB”) issued
guidance on testing goodwill for impairment. The new guidance provides an entity
the option to first perform a qualitative assessment to determine whether it is
more likely than not that the fair value of a reporting unit is less than its
carrying amount. If an entity determines that this is the case, it is required
to perform the two-step goodwill impairment test to identify potential goodwill
impairment and measure the amount of goodwill impairment loss to be recognized
for that reporting unit (if any). If an entity determines that the fair value of
a reporting unit is greater than its carrying amount, the two-step goodwill
impairment test is not required. We adopted this new guidance beginning July 1,
2012. Adoption of this new guidance did not have a material impact on our
financial statements.

 

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In June 2011, the FASB issued guidance on presentation of comprehensive
income. The new guidance eliminated the option to report OCI and its components
in the statement of changes in stockholders’ equity. Instead, an entity is
required to present either a continuous statement of net income and OCI or in
two separate but consecutive statements. We adopted this new guidance beginning
July 1, 2012. Adoption of this new guidance resulted only in changes to
presentation of our financial statements.

Recent accounting guidance not yet adopted

In December 2011, the FASB issued guidance enhancing disclosure requirements
about the nature of an entity’s right to offset and related arrangements
associated with its financial instruments and derivative instruments. The new
guidance requires the disclosure of the gross amounts subject to rights of
set-off, amounts offset in accordance with the accounting standards followed,
and the related net exposure. In January 2013, the FASB clarified that the scope
of this guidance applies to derivatives, including bifurcated embedded
derivatives, repurchase agreements and reverse repurchase agreements, and
securities borrowing and securities lending transactions that are either offset
or subject to an enforceable master netting arrangement, or similar agreements.
The new guidance will be effective for us beginning July 1, 2013. Other than
requiring additional disclosures, we do not anticipate material impacts on our
financial statements upon adoption.

In February 2013, the FASB issued guidance on disclosure requirements for items
reclassified out of AOCI. This new guidance requires entities to present (either
on the face of the income statement or in the notes) the effects on the line
items of the income statement for amounts reclassified out of AOCI. The new
guidance will be effective for us beginning July 1, 2013. Other than requiring
additional disclosures, we do not anticipate material impacts on our financial
statements upon adoption.

In March 2013, the FASB issued guidance on a parent’s accounting for the
cumulative translation adjustment upon derecognition of a subsidiary or group of
assets within a foreign entity. This new guidance requires that the parent
release any related cumulative translation adjustment into net income only if
the sale or transfer results in the complete or substantially complete
liquidation of the foreign entity in which the subsidiary or group of assets had
resided. The new guidance will be effective for us beginning July 1, 2014. We do
not anticipate material impacts on our financial statements upon adoption.

                          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, stock awards, and shared performance stock awards.

The components of basic and diluted EPS are as follows:

 

(In millions, except earnings per share)                                                            
-------------------------------------------------------------------------------------------------- -
                                                                                      
Year Ended June 30,                                             2013           2012           2011  
                                                                                      
Net income available for common shareholders (A)           $  21,863      $  16,978      $  23,150  
                                                                                      
Weighted average outstanding shares of common stock (B)        8,375          8,396          8,490  
Dilutive effect of stock-based awards                             95            110            103  
-------------------------------------------------------------------- -    - ------- -    - ------- -
Common stock and common stock equivalents (C)                  8,470          8,506          8,593  
                                                           - ------- -    - ------- -    - ------- -
                                                                                      
Earnings Per Share                                                                                  
                                                                                      
Basic (A/B)                                                $    2.61      $    2.02      $    2.73  
Diluted (A/C)                                              $    2.58      $    2.00      $    2.69  
-------------------------------------------------------------------------------------------------- -


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

 

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                        NOTE 3 — OTHER INCOME (EXPENSE)

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

 

    (In millions)                                                                       
    --------------------------------------------------------------------------------- --
                                                                            
    Year Ended June 30,                                2013         2012         2011   
                                                                            
    Dividends and interest income                   $   677      $   800      $   900   
    Interest expense                                   (429 )       (380 )       (295 ) 
    Net recognized gains on investments                 116          564          439   
    Net losses on derivatives                          (196 )       (364 )        (77 ) 
    Net losses on foreign currency remeasurements       (74 )       (117 )        (26 ) 
    Other                                               194            1          (31 ) 
    ------------------------------------------------------- --   - ----- --   - ----- --
    Total                                           $   288      $   504      $   910   
                                                    - ----- --   - ----- --   - ----- --


Following are details of net recognized gains (losses) on investments during the
periods reported:

 

(In millions)                                                                                  
-------------------------------------------------------------------------------------------- --
                                                                                  
Year Ended June 30,                                        2013           2012          2011   
                                                                                  
Other-than-temporary impairments of investments         $  (208 )     $   (298 )     $   (80 ) 
Realized gains from sales of available-for-sale                                              
securities                                                  489          1,418           734   
Realized losses from sales of available-for-sale                                             
securities                                                 (165 )         (556 )        (215 ) 
--------------------------------------------------------------- --    - ------ --    - ----- --
Total                                                   $   116       $    564       $   439   
                                                        - ----- --    - ------ --    - ----- --


                              NOTE 4 — INVESTMENTS

Investment Components

The components of investments, including associated derivatives, were as
follows:

 

                                                                                                               Cash                                Equity 
                                                    Unrealized        Unrealized        Recorded           and Cash         Short-term          and Other 
(In millions)                     Cost Basis             Gains            Losses           Basis        Equivalents        Investments        Investments  
--------------------------------------------------------------------------------------------------------------------------------------------------------- -
                                                                                                                                         
June 30, 2013                                                                                                                                              
                                                                                                                                         
Cash                            $      1,967      $          0      $          0       $   1,967      $       1,967      $           0      $           0  
Mutual funds                             868                 0                 0             868                868                  0                  0  
Commercial paper                         603                 0                 0             603                214                389                  0  
Certificates of deposit                  994                 0                 0             994                609                385                  0  
U.S. government and                                                                                                                                       
agency securities                     64,934                47               (84 )        64,897                146             64,751                  0  
Foreign government bonds                 900                16               (41 )           875                  0                875                  0  
Mortgage-backed securities             1,258                43               (13 )         1,288                  0              1,288                  0  
Corporate notes and bonds              4,993               169               (40 )         5,122                  0              5,122                  0  
Municipal securities                     350                36                (1 )           385                  0                385                  0  
Common and preferred stock             6,931             2,938              (281 )         9,588                  0                  0              9,588  
Other investments                      1,279                 0                 0           1,279                  0                 23              1,256  
-------------------------------------------- -    -- --------- -    -- --------- --    - ------- -    -- ---------- -    -- ---------- -    -- ---------- -
Total                           $     85,077      $      3,249      $       (460 )     $  87,866      $       3,804      $      73,218      $      10,844  
                                -- --------- -    -- --------- -    -- --------- --    - ------- -    -- ---------- -    -- ---------- -    -- ---------- -


 

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                                                                                                                Cash                                Equity 
                                                     Unrealized        Unrealized        Recorded           and Cash         Short-term          and Other 
(In millions)                      Cost Basis             Gains            Losses           Basis        Equivalents        Investments        Investments  
---------------------------------------------------------------------------------------------------------------------------------------------------------- -
                                                                                                                                          
June 30, 2012                                                                                                                                               
                                                                                                                                          
Cash                             $      2,019      $          0      $          0       $   2,019      $       2,019      $           0      $           0  
Mutual funds                              820                 0                 0             820                820                  0                  0  
Commercial paper                           96                 0                 0              96                 96                  0                  0  
Certificates of deposit                   744                 0                 0             744                342                402                  0  
U.S. government and                                                                                                                                        
agency securities                      47,178               130                (2 )        47,306                561             46,745                  0  
Foreign government bonds                1,741                18               (29 )         1,730                575              1,155                  0  
Mortgage-backed securities              1,816                82                (2 )         1,896                  0              1,896                  0  
Corporate notes and bonds               7,799               224               (15 )         8,008              2,525              5,483                  0  
Municipal securities                      358                58                (0 )           416                  0                416                  0  
Common and preferred stock              6,965             2,204              (436 )         8,733                  0                  0              8,733  
Other investments                       1,048                 0                 0           1,048                  0                  5              1,043  
--------------------------------------------- -    -- --------- -    -- --------- --    - ------- -    -- ---------- -    -- ---------- -    -- ---------- -
Total                            $     70,584      $      2,716      $       (484 )     $  72,816      $       6,938      $      56,102      $       9,776  
                                 -- --------- -    -- --------- -    -- --------- --    - ------- -    -- ---------- -    -- ---------- -    -- ---------- -


Unrealized Losses on Investments

Investments with continuous unrealized losses for less than 12 months and 12
months or greater and their related fair values were as follows:

 

                                                   Less than 12 Months                  12 Months or Greater                                    
                                        -- --------------------------- --   --- ---------------------------- --                           Total 
                                                            Unrealized                            Unrealized             Total       Unrealized 
(In millions)                             Fair Value            Losses        Fair Value              Losses        Fair Value           Losses   
----------------------------------------------------------------------------------------------------------------------------------------------- --
                                                                                                                                 
June 30, 2013                                                                                                                                     
                                                                                                                                 
U.S. government and agency securities   $      2,208      $        (84 )    $          0       $           0      $      2,208     $        (84 ) 
Foreign government bonds                         589               (18 )              69                 (23 )             658              (41 ) 
Mortgage-backed securities                       357               (12 )              39                  (1 )             396              (13 ) 
Corporate notes and bonds                      1,142               (38 )              27                  (2 )           1,169              (40 ) 
Municipal securities                              44                (1 )               0                   0                44               (1 ) 
Common and preferred stock                     1,166              (168 )             409                (113 )           1,575             (281 ) 
---------------------------------------------------- --   -- --------- --   --- -------- --    --- --------- --   -- --------- -   -- --------- --
Total                                   $      5,506      $       (321 )    $        544       $        (139 )    $      6,050     $       (460 ) 
                                        -- --------- --   -- --------- --   --- -------- --    --- --------- --   -- --------- -   -- --------- --


 

                                                   Less than 12 Months                  12 Months or Greater                                    
                                        -- --------------------------- --   --- ---------------------------- --                           Total 
                                                            Unrealized                            Unrealized             Total       Unrealized 
(In millions)                             Fair Value            Losses        Fair Value              Losses        Fair Value           Losses   
----------------------------------------------------------------------------------------------------------------------------------------------- --
                                                                                                                                 
June 30, 2012                                                                                                                                     
                                                                                                                                 
U.S. government and agency securities   $         44      $         (2 )    $          0       $           0      $         44     $         (2 ) 
Foreign government bonds                         657               (27 )              12                  (2 )             669              (29 ) 
Mortgage-backed securities                        53                 0                48                  (2 )             101               (2 ) 
Corporate notes and bonds                        640               (11 )              70                  (4 )             710              (15 ) 
Common and preferred stock                     2,135              (329 )             305                (107 )           2,440             (436 ) 
---------------------------------------------------- --   -- --------- --   --- -------- --    --- --------- --   -- --------- -   -- --------- --
Total                                   $      3,529      $       (369 )    $        435       $        (115 )    $      3,964     $       (484 ) 
                                        -- --------- --   -- --------- --   --- -------- --    --- --------- --   -- --------- -   -- --------- --


Unrealized losses from fixed-income securities are primarily attributable to
changes in interest rates. Unrealized losses from domestic and international
equities are due to market price movements. Management does not believe any
remaining unrealized losses represent other-than-temporary impairments based on
our evaluation of available evidence as of June 30, 2013.

 

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At June 30, 2013 and 2012, the recorded bases of common and preferred stock and
other investments that are restricted for more than one year or are not publicly
traded were $395 million and $313 million, respectively. These investments are
carried at cost and are reviewed quarterly for indicators of
other-than-temporary impairment. It is not practicable for us to reliably
estimate the fair value of these investments.

Debt Investment Maturities

 

                                                                    Estimated 
        (In millions)                             Cost Basis       Fair Value  
        --------------------------------------------------------------------- -
                                                               
        June 30, 2013                                                          
                                                               
        Due in one year or less                 $     26,386     $     26,412  
        Due after one year through five years         42,343           42,400  
        Due after five years through 10 years          3,293            3,303  
        Due after 10 years                             2,010            2,049  
        ---------------------------------------------------- -   -- --------- -
        Total                                   $     74,032     $     74,164  
                                                -- --------- -   -- --------- -


                              NOTE 5 — DERIVATIVES

We use derivative instruments to manage risks related to foreign currencies,
equity prices, interest rates, and credit; to enhance investment returns; and to
facilitate portfolio diversification. Our objectives for holding derivatives
include reducing, eliminating, and efficiently managing the economic impact of
these exposures as effectively as possible.

Our derivative programs include strategies that both qualify and do not qualify
for hedge accounting treatment. All notional amounts presented below are
measured in U.S. dollar equivalents.

Foreign Currency

Certain forecasted transactions, assets, and liabilities are exposed to foreign
currency risk. We monitor our foreign currency exposures daily to maximize the
economic effectiveness of our foreign currency hedge positions. Option and
forward contracts are used to hedge a portion of forecasted international
revenue for up to three years in the future and are designated as cash flow
hedging instruments. Principal currencies hedged include the euro, Japanese yen,
British pound, and Canadian dollar. As of June 30, 2013 and June 30, 2012, the
total notional amounts of these foreign exchange contracts sold were $5.1
billion and $6.7 billion, respectively.

Foreign currency risks related to certain non-U.S. dollar denominated securities
are hedged using foreign exchange forward contracts that are designated as fair
value hedging instruments. As of June 30, 2013 and June 30, 2012, the total
notional amounts of these foreign exchange contracts sold were $407 million and
$1.3 billion, respectively.

Certain options and forwards not designated as hedging instruments are also used
to manage the variability in exchange rates on accounts receivable, cash, and
intercompany positions, and to manage other foreign currency exposures. As of
June 30, 2013, the total notional amounts of these foreign exchange contracts
purchased and sold were $5.0 billion and $7.9 billion, respectively. As of
June 30, 2012, the total notional amounts of these foreign exchange contracts
purchased and sold were $3.6 billion and $7.3 billion, respectively.

Equity

Securities held in our equity and other investments portfolio are subject to
market price risk. Market price risk is managed relative to broad-based global
and domestic equity indices using certain convertible preferred investments,
options, futures, and swap contracts not designated as hedging instruments. From
time to time, to hedge our price risk, we may use and designate equity
derivatives as hedging instruments, including puts, calls, swaps, and
forwards. As of June 30, 2013, the total notional amounts of designated and
non-designated equity contracts

 

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purchased and sold were $898 million and $1.0 billion, respectively. As of
June 30, 2012, the total notional amounts of designated and non-designated
equity contracts purchased and sold were $1.4 billion and $982 million,
respectively.

Interest Rate

Securities held in our fixed-income portfolio are subject to different interest
rate risks based on their maturities. We manage the average maturity of our
fixed-income portfolio to achieve economic returns that correlate to certain
broad-based fixed-income indices using exchange-traded option and futures
contracts and over-the-counter swap and option contracts, none of which are
designated as hedging instruments. As of June 30, 2013, the total notional
amounts of fixed-interest rate contracts purchased and sold were $1.1 billion
and $809 million, respectively. As of June 30, 2012, the total notional amounts
of fixed-interest rate contracts purchased and sold were $3.2 billion and $1.9
billion, respectively.

In addition, we use “To Be Announced” forward purchase commitments of
mortgage-backed assets to gain exposure to agency mortgage-backed
securities. These meet the definition of a derivative instrument in cases where
physical delivery of the assets is not taken at the earliest available delivery
date. As of June 30, 2013 and 2012, the total notional derivative amounts of
mortgage contracts purchased were $1.2 billion and $1.1 billion, respectively.

Credit

Our fixed-income portfolio is diversified and consists primarily of
investment-grade securities. We use credit default swap contracts, not
designated as hedging instruments, to manage credit exposures relative to
broad-based indices and to facilitate portfolio diversification. We use credit
default swaps as they are a low cost method of managing exposure to individual
credit risks or groups of credit risks. As of June 30, 2013, the total notional
amounts of credit contracts purchased and sold were $377 million and $501
million, respectively. As of June 30, 2012, the total notional amounts of credit
contracts purchased and sold were $318 million and $456 million, respectively.

Commodity

We use broad-based commodity exposures to enhance portfolio returns and to
facilitate portfolio diversification. We use swaps, futures, and option
contracts, not designated as hedging instruments, to generate and manage
exposures to broad-based commodity indices. We use derivatives on commodities as
they can be low-cost alternatives to the purchase and storage of a variety of
commodities, including, but not limited to, precious metals, energy, and grain.
As of June 30, 2013, the total notional amounts of commodity contracts purchased
and sold were $1.2 billion and $249 million, respectively. As of June 30, 2012,
the total notional amounts of commodity contracts purchased and sold were $1.5
billion and $445 million, respectively.

Credit-Risk-Related Contingent Features

Certain of our counterparty agreements for derivative instruments contain
provisions that require our issued and outstanding long-term unsecured debt to
maintain an investment grade credit rating and require us to maintain minimum
liquidity of $1.0 billion. To the extent we fail to meet these requirements, we
will be required to post collateral, similar to the standard convention related
to over-the-counter derivatives. As of June 30, 2013, our long-term unsecured
debt rating was AAA, and cash investments were in excess of $1.0 billion. As a
result, no collateral was required to be posted.

 

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Fair Values of Derivative Instruments

The following tables present the gross fair values of derivative instruments
designated as hedging instruments (“designated hedge derivatives”) and not
designated as hedging instruments (“non-designated hedge derivatives”). The fair
values exclude the impact of netting derivative assets and liabilities when a
legally enforceable master netting agreement exists and fair value adjustments
related to our own credit risk and counterparty credit risk:

 

                                          Foreign                              Interest                                                            
                                         Exchange             Equity               Rate             Credit          Commodity                Total 
(In millions)                           Contracts          Contracts          Contracts          Contracts          Contracts          Derivatives   
-------------------------------------------------------------------------------------------------------------------------------------------------- --
                                                                                                                                 
June 30, 2013                                                                                                                                        
                                                                                                                                 
Assets                                                                                                                                               
                                                                                                                                 
Non-designated hedge derivatives:                                                                                                                    
Short-term investments                $        41        $       157        $        18        $        19        $         3        $         238   
Other current assets                           87                  0                  0                  0                  0                   87   
------------------------------------------------- --     -- -------- --     -- -------- --     -- -------- --     --- ------- --     -- ---------- --
Total                                 $       128        $       157        $        18        $        19        $         3        $         325   
Designated hedge derivatives:                                                                                                                        
Short-term investments                $         9        $         0        $         0        $         0        $         0        $           9   
Other current assets                          167                  0                  0                  0                  0                  167   
------------------------------------------------- --     -- -------- --     -- -------- --     -- -------- --     --- ------- --     -- ---------- --
Total                                 $       176        $         0        $         0        $         0        $         0        $         176   
                                      -- -------- --     -- -------- --     -- -------- --     -- -------- --     --- ------- --     -- ---------- --
Total assets                          $       304        $       157        $        18        $        19        $         3        $         501   
                                      -- -------- --     -- -------- --     -- -------- --     -- -------- --     --- ------- --     -- ---------- --
                                                                                                                                 
Liabilities                                                                                                                                          
                                                                                                                                 
Non-designated hedge derivatives:                                                                                                                    
Other current liabilities             $       (63 )      $        (9 )      $       (45 )      $       (17 )      $        (1 )      $        (135 ) 
Designated hedge derivatives:                                                                                                                        
Other current liabilities             $         0        $         0        $         0        $         0        $         0        $           0   
------------------------------------------------- --     -- -------- --     -- -------- --     -- -------- --     --- ------- --     -- ---------- --
Total liabilities                     $       (63 )      $        (9 )      $       (45 )      $       (17 )      $        (1 )      $        (135 ) 
                                      -- -------- --     -- -------- --     -- -------- --     -- -------- --     --- ------- --     -- ---------- --


 

                                          Foreign                              Interest                                                           
                                         Exchange             Equity               Rate             Credit          Commodity               Total 
(In millions)                           Contracts          Contracts          Contracts          Contracts          Contracts         Derivatives   
------------------------------------------------------------------------------------------------------------------------------------------------- --
                                                                                                                                
June 30, 2012                                                                                                                                       
                                                                                                                                
Assets                                                                                                                                              
                                                                                                                                
Non-designated hedge derivatives:                                                                                                                   
Short-term investments                $        14        $       162        $        10        $        26        $         3       $         215   
Other current assets                           85                  0                  0                  0                  0                  85   
------------------------------------------------- --     -- -------- --     -- -------- --     -- -------- --     --- ------- -     -- ---------- --
Total                                 $        99        $       162        $        10        $        26        $         3       $         300   
Designated hedge derivatives:                                                                                                                       
Short-term investments                $         6        $         0        $         0        $         0        $         0       $           6   
Other current assets                          177                  0                  0                  0                  0                 177   
------------------------------------------------- --     -- -------- --     -- -------- --     -- -------- --     --- ------- -     -- ---------- --
Total                                 $       183        $         0        $         0        $         0        $         0       $         183   
                                      -- -------- --     -- -------- --     -- -------- --     -- -------- --     --- ------- -     -- ---------- --
Total assets                          $       282        $       162        $        10        $        26        $         3       $         483   
                                      -- -------- --     -- -------- --     -- -------- --     -- -------- --     --- ------- -     -- ---------- --
                                                                                                                                
Liabilities                                                                                                                                         
                                                                                                                                
Non-designated hedge derivatives:                                                                                                                   
Other current liabilities             $       (84 )      $       (19 )      $       (17 )      $       (21 )      $         0       $        (141 ) 
Designated hedge derivatives:                                                                                                                       
Other current liabilities             $       (14 )      $         0        $         0        $         0        $         0       $         (14 ) 
------------------------------------------------- --     -- -------- --     -- -------- --     -- -------- --     --- ------- -     -- ---------- --
Total liabilities                     $       (98 )      $       (19 )      $       (17 )      $       (21 )      $         0       $        (155 ) 
                                      -- -------- --     -- -------- --     -- -------- --     -- -------- --     --- ------- -     -- ---------- --


See also Note 4 – Investments and Note 6 – Fair Value Measurements.

 

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Fair Value Hedge Gains (Losses)

We recognized in other income (expense) the following gains (losses) on
contracts designated as fair value hedges and their related hedged items:

 

               (In millions)                                                 
               ----------------------------------------------------------- --
                                                                  
               Year Ended June 30,            2013        2012        2011   
                                                                  
               Foreign Exchange Contracts                                    
                                                                  
               Derivatives                  $   70      $   52      $  (92 ) 
               Hedged items                    (69 )       (50 )        85   
               ----------------------------------- --   - ---- --   - ---- --
               Total                        $    1      $    2      $   (7 ) 
                                            - ---- --   - ---- --   - ---- --


Cash Flow Hedge Gains (Losses)

We recognized the following gains (losses) on foreign exchange contracts
designated as cash flow hedges (our only cash flow hedges during the periods
presented):

 

(In millions)                                                                                    
---------------------------------------------------------------------------------------------- --
                                                                                   
Year Ended June 30,                                         2013           2012           2011   
                                                                                   
Effective Portion                                                                                
                                                                                   
Gains (losses) recognized in OCI, net of tax effects                                           
of $54, $127 and $(340)                                  $   101       $    236       $   (632 ) 
Gains (losses) reclassified from AOCI into revenue       $   195       $    (27 )     $     (7 ) 
                                                                                   
Amount Excluded from Effectiveness Assessment and                                              
Ineffective Portion                                                                              
                                                                                   
Losses recognized in other income (expense)              $  (168 )     $   (231 )     $   (276 ) 


--------------------------------------------------------------------------------
We estimate that $95 million of net derivative gains included in AOCI at
June 30, 2013 will be reclassified into earnings within the following 12 months.
No significant amounts of gains (losses) were reclassified from AOCI into
earnings as a result of forecasted transactions that failed to occur during
fiscal year 2013.

Non-Designated Derivative Gains (Losses)

Gains (losses) from changes in fair values of derivatives that are not
designated as hedges are primarily recognized in other income (expense). These
amounts are shown in the table below, with the exception of gains (losses) on
derivatives presented in income statement line items other than other income
(expense), which were immaterial for the periods presented. Other than those
derivatives entered into for investment purposes, such as commodity contracts,
the gains (losses) below are generally economically offset by unrealized gains
(losses) in the underlying available-for-sale securities.

 

             (In millions)                                                    
             -------------------------------------------------------------- --
                                                                  
             Year Ended June 30,            2013          2012         2011   
                                                                  
             Foreign exchange contracts   $   18      $   (119 )    $   (27 ) 
             Equity contracts                 16           (85 )         35   
             Interest-rate contracts         (11 )          93           19   
             Credit contracts                 (3 )          (7 )         24   
             Commodity contracts             (42 )        (121 )        148   
             ----------------------------------- --   - ------ --   - ----- --
             Total                        $  (22 )    $   (239 )    $   199   
                                          - ---- --   - ------ --   - ----- --


 

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                        NOTE 6 — FAIR VALUE MEASUREMENTS

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables present the fair value of our financial instruments that
are measured at fair value on a recurring basis:

 

                                                                                  Gross                                   
                                                                                   Fair                          Net Fair   
(In millions)                      Level 1        Level 2        Level 3          Value        Netting  (a)         Value   
------------------------------------------------------------------------------------------------------------------------- --
                                                                                                             
June 30, 2013                                                                                                               
                                                                                                             
Assets                                                                                                                      
                                                                                                             
Mutual funds                     $     868      $       0      $       0      $     868      $       0         $      868   
Commercial paper                         0            603              0            603              0                603   
Certificates of deposit                  0            994              0            994              0                994   
U.S. government and agency                                                                                                
securities                          62,237          2,664              0         64,901              0             64,901   
Foreign government bonds                 9            851              0            860              0                860   
Mortgage-backed securities               0          1,311              0          1,311              0              1,311   
Corporate notes and bonds                0          4,915             19          4,934              0              4,934   
Municipal securities                     0            385              0            385              0                385   
Common and preferred stock           8,470            717              5          9,192              0              9,192   
Derivatives                             12            489              0            501            (81 )              420   
------------------------------------------ --   - ------- --   - ------- --   - ------- --   - ------- -----   - -------- --
Total                            $  71,596      $  12,929      $      24      $  84,549      $     (81 )       $   84,468   
                                 - ------- --   - ------- --   - ------- --   - ------- --   - ------- -----   - -------- --
                                                                                                             
Liabilities                                                                                                                 
                                                                                                             
Derivatives and other            $      14      $     121      $       0      $     135      $     (80 )       $       55   
------------------------------------------------------------------------------------------------------------------------- --
                                                                                                             
                                                                                  Gross                                   
                                                                                   Fair                          Net Fair   
(In millions)                      Level 1        Level 2        Level 3          Value        Netting  (a)         Value   
------------------------------------------------------------------------------------------------------------------------- --
                                                                                                             
June 30, 2012                                                                                                               
                                                                                                             
Assets                                                                                                                      
                                                                                                             
Mutual funds                     $     820      $       0      $       0      $     820      $       0         $      820   
Commercial paper                         0             96              0             96              0                 96   
Certificates of deposit                  0            744              0            744              0                744   
U.S. government and agency                                                                                                
securities                          42,291          5,019              0         47,310              0             47,310   
Foreign government bonds                31          1,703              0          1,734              0              1,734   
Mortgage-backed securities               0          1,892              0          1,892              0              1,892   
Corporate notes and bonds                0          7,839              9          7,848              0              7,848   
Municipal securities                     0            416              0            416              0                416   
Common and preferred stock           7,539            877              5          8,421              0              8,421   
Derivatives                             16            467              0            483           (141 )              342   
------------------------------------------ --   - ------- --   - ------- --   - ------- --   - ------- -----   - -------- --
Total                            $  50,697      $  19,053      $      14      $  69,764      $    (141 )       $   69,623   
                                 - ------- --   - ------- --   - ------- --   - ------- --   - ------- -----   - -------- --
                                                                                                             
Liabilities                                                                                                                 
                                                                                                             
Derivatives and other            $      10      $     145      $       0      $     155      $    (139 )       $       16   


--------------------------------------------------------------------------------
 

(a) These amounts represent the impact of netting derivative assets and          
    derivative liabilities when a legally enforceable master netting agreement   
    exists and fair value adjustments related to our own credit risk and         
    counterparty credit risk.                                                    


The changes in our Level 3 financial instruments that are measured at fair value
on a recurring basis were immaterial during the periods presented.

 

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The following table reconciles the total Net Fair Value of assets above to the
balance sheet presentation of these same assets in Note 4 – Investments.

 

(In millions)                                                                               
----------------------------------------------------------------------------------------- --
                                                                             
June 30,                                                             2013            2012   
                                                                             
Net fair value of assets measured at fair value on a                                      
recurring basis                                                 $  84,468       $  69,623   
Cash                                                                1,967           2,019   
Common and preferred stock measured at fair value on a                                    
nonrecurring basis                                                    395             313   
Other investments measured at fair value on a nonrecurring                                
basis                                                               1,256           1,043   
Less derivative net assets classified as other current                                    
assets                                                               (213 )          (185 ) 
Other                                                                  (7 )             3   
------------------------------------------------------------------------- --    - ------- --
Recorded basis of investment components                         $  87,866       $  72,816   
                                                                - ------- --    - ------- --


Financial Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

During fiscal year 2013 and 2012, we did not record any material
other-than-temporary impairments on financial assets required to be measured at
fair value on a nonrecurring basis.

                              NOTE 7 — INVENTORIES

The components of inventories were as follows:

 

                       (In millions)                            
                       --------------------------------------- -
                                                    
                       June 30,              2013         2012  
                                                    
                       Raw materials     $    328     $    210  
                       Work in process        201           96  
                       Finished goods       1,409          831  
                       -------------------------- -   - ------ -
                       Total             $  1,938     $  1,137  
                                         - ------ -   - ------ -


                        NOTE 8 — PROPERTY AND EQUIPMENT

The components of property and equipment were as follows:

 

            (In millions)                                                  
            ------------------------------------------------------------ --
                                                            
            June 30,                                2013            2012   
                                                            
            Land                              $      525      $      528   
            Buildings and improvements             7,326           6,768   
            Leasehold improvements                 2,946           2,550   
            Computer equipment and software        9,242           7,298   
            Furniture and equipment                2,465           2,087   
            -------------------------------------------- --   - -------- --
            Total, at cost                        22,504          19,231   
            Accumulated depreciation             (12,513 )       (10,962 ) 
            -------------------------------------------- --   - -------- --
            Total, net                        $    9,991      $    8,269   
                                              - -------- --   - -------- --


During fiscal years 2013, 2012, and 2011, depreciation expense was $2.6 billion,
$2.2 billion, and $2.0 billion, respectively.

 

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                         NOTE 9 — BUSINESS COMBINATIONS

Yammer

On July 18, 2012, we acquired Yammer, Inc. (“Yammer”), a leading provider of
enterprise social networks, for $1.1 billion in cash. Yammer will continue to
develop its standalone service and will add an enterprise social networking
service to Microsoft’s portfolio of complementary cloud-based services. The
major classes of assets to which we allocated the purchase price were goodwill
of $937 million and identifiable intangible assets of $178 million. We assigned
the goodwill to the Microsoft Business Division. Yammer was consolidated into
our results of operations starting on the acquisition date.

Skype

On October 13, 2011, we acquired all of the issued and outstanding shares of
Skype Global S.á r.l. (“Skype”), a leading global provider of software
applications and related Internet communications products based in Luxembourg,
for $8.6 billion, primarily in cash. The major classes of assets and liabilities
to which we allocated the purchase price were goodwill of $7.1 billion,
identifiable intangible assets of $1.6 billion, and unearned revenue of $222
million. The goodwill recognized in connection with the acquisition is primarily
attributable to our expectation of extending Skype’s brand and the reach of its
networked platform, while enhancing Microsoft’s existing portfolio of real-time
communications products and services. We assigned the goodwill to the following
segments: $4.2 billion to Entertainment and Devices Division, $2.8 billion to
Microsoft Business Division, and $54 million to Online Services Division. Skype
was consolidated into our results of operations starting on the acquisition
date.

Following are the details of the purchase price allocated to the intangible
assets acquired:

 

                                                                 Weighted 
            (In millions)                                    Average Life  
            ------------------------------------------------------------- -
            Marketing-related (trade names)   $  1,249           15 years  
            Technology-based                       275            5 years  
            Customer-related                       114            5 years  
            Contract-based                          10            4 years  
            ------------------------------------------ -                   
            Total                             $  1,648           13 years  
                                              - ------ -                   


Other

During fiscal year 2013, we completed 11 additional acquisitions for total
consideration of $437 million, all of which was paid in cash. These entities
have been included in our consolidated results of operations since their
respective acquisition dates.

Pro forma results of operations have not been presented because the effects of
the business combinations described in this Note, individually and in aggregate,
were not material to our consolidated results of operations.

                               NOTE 10 — GOODWILL

Changes in the carrying amount of goodwill were as follows:

 

                                   Balance as                                             Balance as                                          Balance as 
                                  of June 30,                                            of June 30,                                         of June 30, 
(In millions)                            2011        Acquisitions          Other                2012        Acquisitions       Other                2013  
-------------------------------------------------------------------------------------------------------------------------------------------------------- -
                                                                                                                                        
Windows Division                $          89      $            0      $       0       $          89      $           12      $    0       $         101  
Server and Tools                        1,139                   7             (2 )             1,144                 217          (3 )             1,358  
Online Services Division                6,373                  54         (6,204 )               223                   0          (5 )               218  
Microsoft Business Division             4,167               2,843           (117 )             6,893                 987         (11 )             7,869  
Entertainment and Devices                                                                                                                                
Division                                  813               4,294             (4 )             5,103                  27         (21 )             5,109  
--------------------------------------------- -    -- ----------- -    - ------- --    -- ---------- -    -- ----------- -    - ---- --    -- ---------- -
Total                           $      12,581      $        7,198      $  (6,327 )     $      13,452      $        1,243      $  (40 )     $      14,655  
                                -- ---------- -    -- ----------- -    - ------- --    -- ---------- -    -- ----------- -    - ---- --    -- ---------- -


 

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The measurement periods for purchase price allocations end as soon as
information on the facts and circumstances becomes available, but do not exceed
12 months. Adjustments in purchase price allocations may require a recasting of
the amounts allocated to goodwill retroactive to the periods in which the
acquisitions occurred.

Any change in the goodwill amounts resulting from foreign currency translations
are presented as “other” in the above table. Also included within “other” are
business dispositions and transfers between business segments due to
reorganizations, as applicable. For fiscal year 2012, a $6.2 billion goodwill
impairment charge was included in “other,” as discussed further below. This
goodwill impairment charge also represented our accumulated goodwill impairment
as of June 30, 2013 and 2012.

Goodwill Impairment

We test goodwill for impairment annually on May 1 at the reporting unit level
using a discounted cash flow methodology with a peer-based, risk-adjusted
weighted average cost of capital. We believe use of a discounted cash flow
approach is the most reliable indicator of the fair values of the businesses.

No impairment of goodwill was identified as of May 1, 2013. Upon completion of
the fiscal year 2012 test, OSD goodwill was determined to be impaired. The
impairment was the result of the OSD unit experiencing slower than projected
growth in search queries and search advertising revenue per query, slower growth
in display revenue, and changes in the timing and implementation of certain
initiatives designed to drive search and display revenue growth in the future.

Because our fiscal year 2012 annual test indicated that OSD’s carrying value
exceeded its estimated fair value, a second phase of the goodwill impairment
test (“Step 2”) was performed specific to OSD. Under Step 2, the fair value of
all OSD assets and liabilities were estimated, including tangible assets,
existing technology, trade names, and partner relationships for the purpose of
deriving an estimate of the implied fair value of goodwill. The implied fair
value of the goodwill was then compared to the recorded goodwill to determine
the amount of the impairment. Assumptions used in measuring the value of these
assets and liabilities included the discount rates, royalty rates, and
obsolescence rates used in valuing the intangible assets, and pricing of
comparable transactions in the market in valuing the tangible assets.

No other instances of impairment were identified in our May 1, 2012 test.

                          NOTE 11 — INTANGIBLE ASSETS

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

 

                           Gross                                                Gross                                        
                        Carrying        Accumulated        Net Carrying      Carrying        Accumulated        Net Carrying 
(In millions)             Amount       Amortization              Amount        Amount       Amortization              Amount  
---------------------------------------------------------------------------------------------------------------------------- -
                                                                                                            
Year Ended June 30,                                                2013                                                 2012  
                                                                                                            
Technology-based (a)   $   3,760     $       (2,110 )    $        1,650     $   3,550     $       (1,899 )    $        1,651  
Marketing-related          1,348               (211 )             1,137         1,325               (136 )             1,189  
Contract-based               823               (688 )               135           824               (644 )               180  
Customer-related             380               (219 )               161           408               (258 )               150  
-------------------------------- -   -- ----------- --   -- ----------- -   -- ------ -   -- ----------- --   -- ----------- -
Total                  $   6,311     $       (3,228 )    $        3,083     $   6,107     $       (2,937 )    $        3,170  
                       -- ------ -   -- ----------- --   -- ----------- -   -- ------ -   -- ----------- --   -- ----------- -


 

(a) Technology-based intangible assets included $218 million and $177 million as 
    of June 30, 2013 and 2012, respectively, of net carrying amount of software  
    to be sold, leased, or otherwise marketed.                                   


We estimate that we have no significant residual value related to our intangible
assets. No material impairments of intangible assets were identified during any
of the periods presented.

 

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The components of intangible assets acquired during the periods presented were
as follows:

 

                                               Weighted                        Weighted 
       (In millions)          Amount       Average Life       Amount       Average Life  
       -------------------------------------------------------------------------------- -
       Year Ended June 30,      2013                            2012                     
                                                                       
       Technology-based      $   539            4 years     $  1,548            7 years  
       Marketing-related          39            7 years        1,249           15 years  
       Contract-based              0                             115            7 years  
       Customer-related           89            6 years          114            5 years  
       ----------------------------- -                      - ------ -                   
       Total                 $   667            5 years     $  3,026           10 years  
                             -- ---- -                      - ------ -                   


Intangible assets amortization expense was $739 million, $558 million, and $537
million for fiscal years 2013, 2012, and 2011, respectively. Amortization of
capitalized software was $210 million, $117 million, and $114 million for fiscal
years 2013, 2012, and 2011, respectively.

The following table outlines the estimated future amortization expense related
to intangible assets held at June 30, 2013:

 

                         (In millions)                    
                         ------------------------------- -
                                              
                         Year Ending June 30,             
                                              
                         2014                   $    645  
                         2015                        454  
                         2016                        382  
                         2017                        281  
                         2018                        242  
                         Thereafter                1,079  
                         ------------------------------- -
                         Total                  $  3,083  
                                                - ------ -


                                 NOTE 12 — DEBT

As of June 30, 2013, the total carrying value and estimated fair value of our
long-term debt, including the current portion, were $15.6 billion and $15.8
billion, respectively. This is compared to a carrying value and estimated fair
value of $11.9 billion and $13.2 billion, respectively, as of June 30, 2012.
These estimated fair values are based on Level 2 inputs.

 

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The components of our long-term debt, including the current portion, and the
associated interest rates were as follows as of June 30, 2013 and 2012:

 

                              Face Value          Face Value        Stated       Effective 
                                June 30,            June 30,      Interest        Interest 
    Due Date                        2013                2012          Rate            Rate  
    -------------------------------------------------------------------------------------- -
                                               (In millions)                                
                                                                             
    Notes                                                                                   
                                                                             
    September 27, 2013      $      1,000     $         1,000        0.875%          1.000%  
    June 1, 2014                   2,000               2,000        2.950%          3.049%  
    September 25, 2015             1,750               1,750        1.625%          1.795%  
    February 8, 2016                 750                 750        2.500%          2.642%  
    November 15, 2017 (a)            600                   *        0.875%          1.084%  
    May 1, 2018 (b)                  450                   *        1.000%          1.106%  
    June 1, 2019                   1,000               1,000        4.200%          4.379%  
    October 1, 2020                1,000               1,000        3.000%          3.137%  
    February 8, 2021                 500                 500        4.000%          4.082%  
    November 15, 2022 (a)            750                   *        2.125%          2.239%  
    May 1, 2023 (b)                1,000                   *        2.375%          2.465%  
    May 2, 2033 (c)                  715                   *        2.625%          2.690%  
    June 1, 2039                     750                 750        5.200%          5.240%  
    October 1, 2040                1,000               1,000        4.500%          4.567%  
    February 8, 2041               1,000               1,000        5.300%          5.361%  
    November 15, 2042 (a)            900                   *        3.500%          3.571%  
    May 1, 2043 (b)                  500                   *        3.750%          3.829%  
    ------------------------------------ -   --- ----------- -                              
    Total                         15,665              10,750                                
                                                                             
    Convertible Debt                                                                        
                                                                             
    June 15, 2013                      0               1,250        0.000%          1.849%  
    ------------------------------------ -   --- ----------- -                              
    Total                   $     15,665     $        12,000                                
                            -- --------- -   --- ----------- -                              


 

(a) In November 2012, we issued $2.25 billion of debt securities.


(b) In April 2013, we issued $1.95 billion of debt securities.


(c) In April 2013, we issued €550 million of debt securities.


* Not applicable.


As of June 30, 2013 and 2012, the aggregate unamortized discount for our
long-term debt, including the current portion, was $65 million and $56 million,
respectively.

Notes

The Notes are senior unsecured obligations and rank equally with our other
unsecured and unsubordinated debt outstanding.

Convertible Debt

In June 2013, we paid cash of $1.25 billion for the principal amount of our zero
coupon convertible unsecured debt and elected to deliver cash for the $96
million excess obligation resulting from the conversion of the notes. Each
$1,000 principal amount of notes was convertible into 30.68 shares of Microsoft
common stock at a conversion price of $32.59 per share. As of June 30, 2012, the
net carrying amount of the convertible debt and the unamortized discount were
$1.2 billion and $19 million, respectively.

In connection with the issuance of the notes in 2010, we entered into capped
call transactions with certain option counterparties with a strike price equal
to the conversion price of the notes. Upon conversion of the notes in June

 

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2013, we exercised the capped calls. The bulk of the capped calls were
physically settled by acquiring 29 million shares of our own common stock for
$938 million. The remaining capped calls were net cash settled for $24 million.

Debt Service

Maturities of our long-term debt for each of the next five years and thereafter
are as follows:

 

                         (In millions)                     
                         -------------------------------- -
                                              
                         Year Ending June 30,              
                                              
                         2014                   $   3,000  
                         2015                           0  
                         2016                       2,500  
                         2017                           0  
                         2018                       1,050  
                         Thereafter                 9,115  
                         -------------------------------- -
                         Total                  $  15,665  
                                                - ------- -


Interest on the notes is paid semi-annually, except for the euro-denominated
debt securities on which interest is paid annually. Cash paid for interest on
our debt for fiscal years 2013, 2012, and 2011 was $371 million, $344 million,
and $197 million, respectively.

Credit Facility

In June 2013, we established a commercial paper program for the issuance and
sale of up to $1.3 billion in commercial paper. As of June 30, 2013, we have not
issued any commercial paper under this program.

In June 2013, we entered into a $1.3 billion credit facility, which will serve
as a back-up for our commercial paper program. As of June 30, 2013, we were in
compliance with the only financial covenant in the credit agreement, which
requires us to maintain a coverage ratio of at least three times earnings before
interest, taxes, depreciation, and amortization to interest expense, as defined
in the credit agreement. The credit facility expires on June 24, 2018. No
amounts were drawn against the credit facility since its inception.

                             NOTE 13 — INCOME TAXES

The components of the provision for income taxes were as follows:

 

             (In millions)                                                     
             ---------------------------------------------------------------- -
                                                                   
             Year Ended June 30,              2013          2012         2011  
                                                                   
             Current Taxes                                                     
                                                                   
             U.S. federal                 $  3,131      $  2,235     $  3,108  
             U.S. state and local              332           153          209  
             International                   1,745         1,947        1,602  
             ------------------------------------- --   - ------ -   - ------ -
             Current taxes                   5,208         4,335        4,919  
                                                                   
             Deferred Taxes                                                    
                                                                   
             Deferred taxes                    (19 )         954            2  
             ------------------------------------- --   - ------ -   - ------ -
             Provision for income taxes   $  5,189      $  5,289     $  4,921  
                                          - ------ --   - ------ -   - ------ -


 

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U.S. and international components of income before income taxes were as follows:

 

            (In millions)                                                       
            ------------------------------------------------------------------ -
                                                                   
            Year Ended June 30,               2013          2012          2011  
                                                                   
            U.S.                         $   6,674     $   1,600     $   8,862  
            International                   20,378        20,667        19,209  
            -------------------------------------- -   - ------- -   - ------- -
            Income before income taxes   $  27,052     $  22,267     $  28,071  
                                         - ------- -   - ------- -   - ------- -


The items accounting for the difference between income taxes computed at the
U.S. federal statutory rate and our effective rate were as follows:

 

--------------------------------------------------------------------------------
      Year Ended June 30,                          2013          2012          2011  
                                                                        
      Federal statutory rate                      35.0%         35.0%         35.0%  
      Effect of:                                                                     
      Foreign earnings taxed at lower rates     (17.5)%       (21.1)%       (15.6)%  
      Goodwill impairment                            0%          9.7%            0%  
      I.R.S. settlement                              0%            0%        (1.7)%  
      Other reconciling items, net                 1.7%          0.2%        (0.2)%  
      ------------------------------------------------- -   - ------- -   - ------- -
      Effective rate                              19.2%         23.8%         17.5%  
                                              - ------- -   - ------- -   - ------- -


The reduction from the federal statutory rate from foreign earnings taxed at
lower rates results from producing and distributing our products and services
through our foreign regional operations centers in Ireland, Singapore, and
Puerto Rico. Our foreign earnings, which are taxed at rates lower than the U.S.
rate and are generated from our regional operating centers, were 79%, 79%, and
78% of our international income before tax in fiscal years 2013, 2012, and 2011,
respectively. In general, other reconciling items consist of interest, U.S.
state income taxes, domestic production deductions, and credits. In fiscal years
2013, 2012, and 2011, there were no individually significant other reconciling
items. The I.R.S. settlement is discussed below.

 

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The components of the deferred income tax assets and liabilities were as
follows:

 

  (In millions)                                                                       
  --------------------------------------------------------------------------------- --
                                                                        
  June 30,                                                      2013           2012   
                                                                        
  Deferred Income Tax Assets                                                          
                                                                        
  Stock-based compensation expense                         $     888      $     882   
  Other expense items                                            917            965   
  Unearned revenue                                               445            571   
  Impaired investments                                           246            152   
  Loss carryforwards                                             715            532   
  Other revenue items                                             55             79   
  ------------------------------------------------------------------ --   - ------- --
  Deferred income tax assets                               $   3,266      $   3,181   
  Less valuation allowance                                      (579 )         (453 ) 
  ------------------------------------------------------------------ --   - ------- --
  Deferred income tax assets, net of valuation allowance   $   2,687      $   2,728   
  ------------------------------------------------------------------ --   - ------- --
                                                                        
  Deferred Income Tax Liabilities                                                     
                                                                        
  International earnings                                   $  (1,146 )    $  (1,072 ) 
  Unrealized gain on investments                              (1,012 )         (830 ) 
  Depreciation and amortization                                 (604 )         (670 ) 
  Other                                                           (2 )          (14 ) 
  ------------------------------------------------------------------ --   - ------- --
  Deferred income tax liabilities                          $  (2,764 )    $  (2,586 ) 
  ------------------------------------------------------------------ --   - ------- --
  Net deferred income tax assets (liabilities)             $     (77 )    $     142   
                                                           - ------- --   - ------- --
                                                                        
  Reported As                                                                         
                                                                        
  Current deferred income tax assets                       $   1,632      $   2,035   
  Long-term deferred income tax liabilities                   (1,709 )       (1,893 ) 
  ------------------------------------------------------------------ --   - ------- --
  Net deferred income tax assets (liabilities)             $     (77 )    $     142   
                                                           - ------- --   - ------- --


As of June 30, 2013, we had net operating loss carryforwards of $2.7 billion,
including $2.2 billion of foreign net operating loss carryforwards acquired
through our acquisition of Skype. The valuation allowance disclosed in the table
above relates to the foreign net operating loss carryforwards that may not be
realized.

Deferred income tax balances reflect the effects of temporary differences
between the carrying amounts of assets and liabilities and their tax bases and
are stated at enacted tax rates expected to be in effect when the taxes are
actually paid or recovered.

As of June 30, 2013, we have not provided deferred U.S. income taxes or foreign
withholding taxes on temporary differences of approximately $76.4 billion
resulting from earnings for certain non-U.S. subsidiaries which are permanently
reinvested outside the U.S. The unrecognized deferred tax liability associated
with these temporary differences was approximately $24.4 billion at June 30,
2013.

Income taxes paid were $3.9 billion, $3.5 billion, and $5.3 billion in fiscal
years 2013, 2012, and 2011, respectively.

Uncertain Tax Positions

As of June 30, 2013, we had $8.6 billion of unrecognized tax benefits of which
$6.5 billion, if recognized, would affect our effective tax rate. As of June 30,
2012, we had $7.2 billion of unrecognized tax benefits of which $6.2 billion, if
recognized, would have affected our effective tax rate.

Interest on unrecognized tax benefits was $400 million, $154 million, and $38
million in fiscal years 2013, 2012, and 2011, respectively. As of June 30, 2013,
2012, and 2011, we had accrued interest related to uncertain tax positions of
$1.3 billion, $939 million, and $785 million, respectively, net of federal
income tax benefits.

 

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The aggregate changes in the balance of unrecognized tax benefits were as
follows:

 

(In millions)                                                                                         
--------------------------------------------------------------------------------------------------- --
                                                                                       
Year Ended June 30,                                            2013            2012            2011   
                                                                                       
Balance, beginning of year                                 $  7,202       $   6,935       $   6,542   
Decreases related to settlements                                (30 )           (16 )          (632 ) 
Increases for tax positions related to the current year         612             481             739   
Increases for tax positions related to prior years              931             118             405   
Decreases for tax positions related to prior years              (65 )          (292 )          (119 ) 
Decreases due to lapsed statutes of limitations                  (2 )           (24 )             0   
------------------------------------------------------------------- --    - ------- --    - ------- --
Balance, end of year                                       $  8,648       $   7,202       $   6,935   
                                                           - ------ --    - ------- --    - ------- --


During the third quarter of fiscal year 2011, we reached a settlement of a
portion of an I.R.S. audit of tax years 2004 to 2006, which reduced our income
tax expense by $461 million. While we settled a portion of the I.R.S. audit, we
remain under audit for these years. In February 2012, the I.R.S. withdrew its
2011 Revenue Agents Report and reopened the audit phase of the examination. As
of June 30, 2013, the primary unresolved issue relates to transfer pricing,
which could have a significant impact on our financial statements if not
resolved favorably. We believe our allowances for tax contingencies are
appropriate. We do not believe it is reasonably possible that the total amount
of unrecognized tax benefits will significantly increase or decrease within the
next 12 months, because we do not believe the remaining open issues will be
resolved within the next 12 months. We also continue to be subject to
examination by the I.R.S. for tax years 2007 to 2012.

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 2012, some of which are currently under audit by local tax authorities.
The resolutions of these audits are not expected to be material to our financial
statements.

                           NOTE 14 — UNEARNED REVENUE

Unearned revenue comprises mainly unearned revenue from volume licensing
programs, and payments for offerings for which we have been paid in advance and
we earn the revenue when we provide the service or software or otherwise meet
the revenue recognition criteria.

Volume Licensing Programs

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

Other

Also included in unearned revenue are payments for post-delivery support and
consulting services to be performed in the future; Xbox LIVE subscriptions and
prepaid points; OEM minimum commitments; Microsoft Dynamics business solutions
products; Skype prepaid credits and subscriptions; and other offerings for which
we have been paid in advance and earn the revenue when we provide the service or
software, or otherwise meet the revenue recognition criteria.

 

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The components of unearned revenue were as follows:

 

                 (In millions)                                        
                 --------------------------------------------------- -
                                                         
                 June 30,                         2013          2012  
                                                         
                 Volume licensing programs   $  18,871     $  16,717  
                 Other (a)                       3,528         3,342  
                 ------------------------------------- -   - ------- -
                 Total                       $  22,399     $  20,059  
                                             - ------- -   - ------- -


 

(a) Other as of June 30, 2012 included $540 million of unearned revenue          
    associated with sales of Windows 7 with an option to upgrade to Windows 8 Pro
    at a discounted price (the “Windows Upgrade Offer”).                         


Unearned revenue by segment was as follows:

 

                (In millions)                                          
                ----------------------------------------------------- -
                                                          
                June 30,                           2013          2012  
                                                          
                Windows Division              $   2,086     $   2,444  
                Server and Tools                  8,639         7,445  
                Microsoft Business Division      10,142         9,015  
                Other segments                    1,532         1,155  
                --------------------------------------- -   - ------- -
                Total                         $  22,399     $  20,059  
                                              - ------- -   - ------- -


                     NOTE 15 — OTHER LONG-TERM LIABILITIES

 

         (In millions)                                                         
         -------------------------------------------------------------------- -
                                                                   
         June 30,                                           2013         2012  
                                                                   
         Tax contingencies and other tax liabilities   $   9,548     $  7,634  
         Legal contingencies                                 162          220  
         Other                                               290          354  
         ------------------------------------------------------- -   - ------ -
         Total                                         $  10,000     $  8,208  
                                                       - ------- -   - ------ -


                      NOTE 16 — COMMITMENTS AND GUARANTEES

Construction and Operating Leases

We have committed $694 million for constructing new buildings, building
improvements, and leasehold improvements as of June 30, 2013.

We have operating leases for most U.S. and international sales and support
offices and certain equipment. Rental expense for facilities operating leases
was $711 million, $639 million, and $525 million, in fiscal years 2013, 2012,
and 2011, respectively. Future minimum rental commitments under non-cancellable
facilities operating leases in place as of June 30, 2013 are as follows:

 

                         (In millions)                    
                         ------------------------------- -
                                              
                         Year Ending June 30,             
                                              
                         2014                   $    572  
                         2015                        451  
                         2016                        349  
                         2017                        281  
                         2018                        204  
                         Thereafter                  605  
                         ------------------------------- -
                         Total                  $  2,462  
                                                - ------ -


 

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Indemnifications

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. We evaluate
estimated losses for these indemnifications, and we consider such factors as the
degree of probability of an unfavorable outcome and the ability to make a
reasonable estimate of the amount of loss. To date, we have not encountered
significant costs as a result of these obligations and have not accrued any
liabilities related to these indemnifications in our financial statements.

                            NOTE 17 — CONTINGENCIES

Antitrust, Unfair Competition, and Overcharge Class Actions

A large number of antitrust and unfair competition class action lawsuits were
filed against us in various state, federal, and Canadian courts on behalf of
various classes of direct and indirect purchasers of our PC operating system and
certain other software products between 1999 and 2005. We obtained dismissals or
reached settlements of all claims made in the United States.

All settlements in the United States have received final court approval. Under
the settlements, generally class members can obtain vouchers that entitle them
to be reimbursed for purchases of a wide variety of platform-neutral computer
hardware and software. The total value of vouchers we may issue varies by state.
We will make available to certain schools a percentage of those vouchers that
are not issued or claimed (one-half to two-thirds depending on the state). The
total value of vouchers we ultimately issue will depend on the number of class
members who make claims and are issued vouchers. The maximum value of vouchers
to be issued is approximately $2.7 billion. The actual costs of these
settlements will be less than that maximum amount, depending on the number of
class members and schools that are issued and redeem vouchers. We estimate the
total cost to resolve all of the state overcharge class action cases will range
between $1.9 billion and $2.0 billion. At June 30, 2013, we have recorded a
liability related to these claims of approximately $500 million, which reflects
our estimated exposure of $1.9 billion less payments made to date of
approximately $1.4 billion mostly for vouchers, legal fees, and administrative
expenses.

The three cases pending in British Columbia, Ontario, and Quebec, Canada have
not been settled. In March 2010, the court in the British Columbia case
certified it as a class action. In April 2011, the British Columbia Court of
Appeal reversed the class certification ruling and dismissed the case, holding
that indirect purchasers do not have a claim. The plaintiffs have filed an
appeal to the Canadian Supreme Court, which was heard in the fall of 2012. The
other two actions have been stayed.

Other Antitrust Litigation and Claims

In November 2004, Novell, Inc. (“Novell”) filed a complaint in U.S. District
Court for the District of Utah (later transferred to federal court in Maryland),
asserting antitrust and unfair competition claims against us related to Novell’s
ownership of WordPerfect and other productivity applications during the period
between June 1994 and March 1996. In June 2005, the trial court granted our
motion to dismiss four of Novell’s six claims. In March 2010, the trial court
granted summary judgment in favor of Microsoft as to all remaining claims. The
court of appeals reversed that ruling as to one claim. Trial of that claim took
place from October to December 2011 and resulted in a mistrial because the jury
was unable to reach a verdict. In July 2012, the trial court granted Microsoft’s
motion for judgment as a matter of law. Novell has appealed this decision to the
U.S. Court of Appeals for the Tenth Circuit, which heard oral arguments in May
2013.

Patent and Intellectual Property Claims

Motorola Litigation

In October 2010, Microsoft filed patent infringement complaints against Motorola
Mobility (“Motorola”) with the International Trade Commission (“ITC”) and in
U.S. District Court in Seattle for infringement of nine Microsoft patents

 

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by Motorola’s Android devices. Since then, Microsoft and Motorola have filed
additional claims against each other in the ITC, in federal district courts in
Seattle, Wisconsin, Florida, and California, and in courts in Germany and the
United Kingdom. In April 2012, following complaints by Microsoft and Apple, the
European Union’s competition office opened two antitrust investigations against
Motorola to determine whether it has abused certain of its standard essential
patents to distort competition in breach of European Union antitrust rules. In
June 2012, we received a request for information from the U.S. Federal Trade
Commission (“FTC”) apparently related to an FTC investigation into whether
Motorola’s conduct violates U.S. law. The nature of the claims asserted and
status of individual matters are summarized below.

International Trade Commission

The hearing in Microsoft’s ITC case against Motorola took place in August 2011
on seven of the nine patents originally asserted in the complaint. In December
2011, the administrative law judge (“ALJ”) issued an initial determination that
Motorola infringed one Microsoft patent, and recommended that the ITC issue a
limited exclusion order against Motorola prohibiting importation of infringing
Motorola Android devices. In May 2012, the ITC issued the limited exclusion
order recommended by the ALJ, which became effective on July 18, 2012. Microsoft
has appealed certain aspects of the ITC ruling adverse to Microsoft and Motorola
has appealed the ITC exclusion order to the Court of Appeals for the Federal
Circuit. In addition, in July 2013, Microsoft filed an action in U.S. district
court in Washington, D.C. seeking an order to compel enforcement of the ITC’s
May 2012 import ban against infringing Motorola products by the Bureau of
Customs and Border Protection (“CBP”), after learning that CBP had failed to
fully enforce the order.

In November 2010, Motorola filed an action against Microsoft in the ITC alleging
infringement of five Motorola patents by Xbox consoles and accessories and
seeking an exclusion order to prohibit importation of the allegedly infringing
Xbox products into the U.S. In April 2012, the ALJ found that Xbox products
infringe four of the five patents asserted by Motorola. The ALJ recommended that
the ITC issue a limited exclusion order and a cease and desist order. Both
Microsoft and Motorola sought ITC review of the ALJ’s findings. In June 2012,
Microsoft filed a motion to terminate the investigation as to certain patents
based on facts arising as the result of Google’s acquisition of Motorola. The
ITC determined that it would review the ALJ’s initial determination in its
entirety and remanded the matter to the ALJ (1) to apply certain ITC case
precedent, (2) to rule on Microsoft’s June 2012 motion to terminate, and (3) set
a new target date for completion of the investigation. The ALJ held a hearing in
December 2012 and set a target date for a final ITC ruling in July 2013. At
Motorola’s request, the ITC terminated its investigation as to four Motorola
patents, leaving only one Motorola patent at issue before the ITC. In March
2013, the ALJ ruled that there has been no violation as to the remaining
Motorola patent. Motorola sought ITC review of the ALJ’s determination, which
the ITC denied in May 2013.

U.S. District Court

The Seattle District Court case filed in October 2010 by Microsoft as a
companion to Microsoft’s ITC case against Motorola has been stayed pending the
outcome of Microsoft’s ITC case.

In November 2010, Microsoft sued Motorola for breach of contract in U.S.
District Court in Seattle, alleging that Motorola breached its commitments to
standards-setting organizations to license to Microsoft certain patents on
reasonable and non-discriminatory (“RAND”) terms and conditions. Motorola has
declared these patents essential to the implementation of the H.264 video
standard and the 802.11 Wi-Fi standard. In suits described below, Motorola or a
Motorola affiliate subsequently sued Microsoft on those patents in U.S. District
Courts, in the ITC, and in Germany. In February 2012, the Seattle District Court
granted a partial summary judgment in favor of Microsoft ruling that
(1) Motorola entered into binding contractual commitments with standards
organizations committing to license its declared-essential patents on RAND terms
and conditions; and (2) Microsoft is a third-party beneficiary of those
commitments. The court rejected Motorola’s argument that Microsoft had
repudiated its right to a RAND license, and ruled a trial is needed to determine
whether Motorola is in breach of its obligation to enter into a patent license
with Microsoft and, if so, the amount of the RAND royalty. In April 2012, the
court issued a temporary restraining order preventing Motorola from taking steps
to enforce an injunction in Germany relating to the H.264 video patents. In May
2012, the court converted that order into a preliminary injunction. Motorola
appealed the court’s injunction

 

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orders to the Court of Appeals for the Ninth Circuit, which affirmed the orders
in September 2012. The Seattle District Court held a trial in November 2012 to
determine the RAND royalty for Motorola’s H.264 and 802.11 patents. In December
2012, the Seattle District Court ruled that Motorola could not obtain injunctive
relief in connection with any of its claims for infringement of its H.264 and
802.11 patents. In April 2013, the court set per unit royalties for Motorola’s
H.264 and 802.11 patents, which resulted in an immaterial Microsoft liability.
Trial of Microsoft’s breach of contract claim is set for August 26, 2013.

Cases filed by Motorola in Wisconsin, California, and Florida, with the
exception of one currently stayed case in Wisconsin (a companion case to
Motorola’s ITC action), have been transferred to the U.S District Court in
Seattle. Motorola and Microsoft both seek damages as well as injunctive relief.
No trial dates have been set in any of the transferred cases, and the court has
stayed these cases on agreement of the parties.

 

     •   In the transferred cases, Motorola asserts 15 patents are infringed by    
         many Microsoft products including Windows Mobile 6.5 and Windows Phone 7, 
         Windows Marketplace, Silverlight, Windows Vista and Windows 7, Exchange   
         Server 2003 and later, Exchange ActiveSync, Windows Live Messenger, Lync  
         Server 2010, Outlook 2010, Office 365, SQL Server, Internet Explorer 9,   
         Xbox, and Kinect.                                                         


 

     •   In the Motorola action originally filed in California, Motorola asserts   
         that Microsoft violated antitrust laws in connection with Microsoft’s     
         assertion of patents against Motorola that Microsoft has agreed to license
         to certain qualifying entities on RAND terms and conditions.              


 

     •   In counterclaims in the patent actions brought by Motorola, Microsoft     
         asserts 14 patents are infringed by Motorola Android devices and certain  
         Motorola digital video recorders.                                         


Germany

In July 2011, Motorola filed patent infringement actions in Germany against
Microsoft and several Microsoft subsidiaries.

 

     •   Two of the patents are asserted by Motorola to be essential to            
         implementation of the H.264 video standard, and Motorola alleges that     
         H.264 capable products including Xbox 360, Windows 7, Media Player, and   
         Internet Explorer infringe those patents. Motorola seeks damages and an   
         injunction. In May 2012, the court issued an injunction relating to all   
         H.264 capable Microsoft products in Germany. However, due to orders in the
         separate litigation pending in Seattle, Washington described above,       
         Motorola is enjoined from taking steps to enforce the German injunction.  
         Damages would be determined in later proceedings. Microsoft has appealed  
         the rulings of the first instance court.                                  


 

     •   Motorola asserts one of the patents covers certain syncing functionality  
         in the ActiveSync protocol employed by Windows Phone 7, Outlook Mobile,   
         Hotmail Mobile, Exchange Online, Exchange Server, and Hotmail Server.     
         Motorola seeks damages and an injunction. In April 2013, the court stayed 
         the case pending the outcome of parallel proceedings in which Microsoft is
         seeking to invalidate the patent.                                         


 

     •   Should an injunction order be issued and enforced by Motorola, Microsoft  
         may be able to mitigate the adverse impact by altering its products to    
         avoid Motorola’s infringement claims.                                     


In lawsuits Microsoft filed in Germany in September, October, and December 2011
and in April 2012, Microsoft asserts Motorola Android devices infringe Microsoft
patents. Microsoft seeks damages and an injunction. In May, July, and September
2012, courts in Germany issued injunctions on three patents against Motorola
Android devices and in May and July ruled against Microsoft on two patents.
Microsoft is taking steps to enforce the injunctions. Damages will be determined
in later proceedings. Each party has appealed or is expected to appeal the
rulings against it. Motorola is also seeking to invalidate Microsoft’s patents
in parallel court proceedings.

United Kingdom

In December 2011, Microsoft filed an action against Motorola in the High Court
of Justice, Chancery Division, Patents Court, in London, England, seeking to
revoke the UK part of the European patent asserted by Motorola in Germany
against the ActiveSync protocol. In February 2012, Motorola counterclaimed
alleging infringement of the

 

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patent and seeking damages and an injunction. A trial took place in December
2012, and the court ruled that Motorola’s patent is invalid and revoked. The
court also ruled that the patent, even if valid, would be licensed under the
grant-back clause in Google’s ActiveSync license. Motorola has appealed.

Other Patent and Intellectual Property Claims

In addition to these cases, there are approximately 65 other patent infringement
cases pending against Microsoft.

Other

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 on our financial statements, these matters
are subject to inherent uncertainties and management’s view of these matters may
change in the future.

As of June 30, 2013, we had accrued aggregate liabilities of $412 million in
other current liabilities and $162 million in other long-term liabilities for
all of our legal matters that were contingencies as of that date. While we
intend to defend these matters vigorously, adverse outcomes that we estimate
could reach approximately $400 million in aggregate beyond recorded amounts are
reasonably possible. Were unfavorable final outcomes to occur, there exists the
possibility of a material adverse impact on our financial statements for the
period in which the effects become reasonably estimable.

                         NOTE 18 — STOCKHOLDERS’ EQUITY

Shares Outstanding

Shares of common stock outstanding were as follows:

 

             (In millions)                                                    
             -------------------------------------------------------------- --
                                                                  
             Year Ended June 30,             2013         2012         2011   
                                                                  
             Balance, beginning of year     8,381        8,376        8,668   
             Issued                           105          147          155   
             Repurchased                     (158 )       (142 )       (447 ) 
             ------------------------------------ --   - ----- --   - ----- --
             Balance, end of year           8,328        8,381        8,376   
                                          - ----- --   - ----- --   - ----- --


Share Repurchases

On September 22, 2008, we announced that our Board of Directors approved a share
repurchase program authorizing up to $40.0 billion in share repurchases with an
expiration date of September 30, 2013. As of June 30, 2013, approximately $3.6
billion of the approved repurchase amount remained. The repurchase program may
be suspended or discontinued at any time without prior notice.

We repurchased the following shares of common stock under the above-described
repurchase plan using cash resources:

 

 (In millions)           Shares        Amount       Shares        Amount       Shares         Amount  
 --------------------------------------------------------------------------------------------------- -
                                                                                         
 Year Ended June 30,                     2013                       2012                        2011  
                                                                                         
 First quarter               33      $  1,000           38      $  1,000          163      $   4,000  
 Second quarter              58         1,607           39         1,000          188          5,000  
 Third quarter               36         1,000           31         1,000           30            827  
 Fourth quarter              31         1,000           34         1,000           66          1,631  
 ------------------------------ --   - ------ -   -- ----- --   - ------ -   -- ----- --   - ------- -
 Total                      158      $  4,607          142      $  4,000          447      $  11,458  
                       -- ----- --   - ------ -   -- ----- --   - ------ -   -- ----- --   - ------- -


 

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Dividends

In fiscal year 2013, our Board of Directors declared the following dividends:

 

                                Dividend                                                                          
Declaration Date               Per Share               Record Date         Total Amount              Payment Date  
----------------------------------------------------------------------------------------------------------------- -
                                                                          (In millions)                            
                                                                                          
September 18, 2012           $      0.23         November 15, 2012       $        1,933         December 13, 2012  
November 28, 2012            $      0.23         February 21, 2013       $        1,925            March 14, 2013  
March 11, 2013               $      0.23              May 16, 2013       $        1,921             June 13, 2013  
June 12, 2013                $      0.23           August 15, 2013       $        1,916        September 12, 2013  


--------------------------------------------------------------------------------
The dividend declared on June 12, 2013 will be paid after the filing date of
this report on Form 10-K and was included in other current liabilities as of
June 30, 2013.

In fiscal year 2012, our Board of Directors declared the following dividends:

 

                                Dividend                                                                          
Declaration Date               Per Share               Record Date         Total Amount              Payment Date  
----------------------------------------------------------------------------------------------------------------- -
                                                                          (In millions)                            
                                                                                          
September 20, 2011           $      0.20         November 17, 2011       $        1,683          December 8, 2011  
December 14, 2011            $      0.20         February 16, 2012       $        1,683             March 8, 2012  
March 13, 2012               $      0.20              May 17, 2012       $        1,678             June 14, 2012  
June 13, 2012                $      0.20           August 16, 2012       $        1,676        September 13, 2012  


--------------------------------------------------------------------------------
The dividend declared on June 13, 2012 was included in other current liabilities
as of June 30, 2012.

                  NOTE 19 — OTHER COMPREHENSIVE INCOME (LOSS)

The activity in other comprehensive income (loss) and related income tax effects
were as follows:

 

(In millions)                                                                                    
---------------------------------------------------------------------------------------------- --
                                                                                    
Year Ended June 30,                                          2013           2012          2011   
                                                                                    
Net Unrealized Gains (Losses) on Derivatives                                                     
                                                                                    
Unrealized gains (losses), net of tax effects of $54,                                          
$127, and $(340)                                          $   101       $    236       $  (632 ) 
Reclassification adjustment for losses (gains)                                                 
included in net income, net of tax effects of $(68),                                           
$10, and $2                                                  (127 )           19             5   
----------------------------------------------------------------- --    - ------ --    - ----- --
Net unrealized gains (losses) on derivatives              $   (26 )     $    255       $  (627 ) 
----------------------------------------------------------------- --    - ------ --    - ----- --
                                                                                    
Net Unrealized Gains (Losses) on Investments                                                     
                                                                                    
Unrealized gains (losses), net of tax effects of $244,                                         
$(93), and $726                                           $   453       $   (172 )     $ 1,349   
Reclassification adjustment for gains included in net                                          
income, net of tax effects of $(49), $(117), and                                               
$(159)                                                        (90 )         (218 )        (295 ) 
----------------------------------------------------------------- --    - ------ --    - ----- --
Net unrealized gains (losses) on investments                  363           (390 )       1,054   
----------------------------------------------------------------- --    - ------ --    - ----- --
Translation adjustments and other, net of tax effects                                          
of $(8), $(165) and $205                                      (16 )         (306 )         381   
----------------------------------------------------------------- --    - ------ --    - ----- --
Other comprehensive income (loss)                         $   321       $  (441)       $   808   
                                                          - ----- --    - ------ --    - ----- --


 

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The components of accumulated other comprehensive income were as follows:

 

   (In millions)                                                                         
   ----------------------------------------------------------------------------------- --
                                                                            
   June 30,                                           2013          2012          2011   
                                                                            
   Net unrealized gains (losses) on derivatives   $     66      $     92      $   (163 ) 
   Net unrealized gains on investments               1,794         1,431         1,821   
   Translation adjustments and other                  (117 )        (101 )         205   
   ------------------------------------------------------- --   - ------ --   - ------ --
   Accumulated other comprehensive income         $  1,743      $  1,422      $  1,863   
                                                  - ------ --   - ------ --   - ------ --


                   NOTE 20 — EMPLOYEE STOCK AND SAVINGS PLANS

We grant stock-based compensation to directors and employees. At June 30, 2013,
an aggregate of 425 million shares were authorized for future grant under our
stock plans, covering stock options, stock awards, and leadership stock awards.
Awards that expire or are canceled without delivery of shares generally become
available for issuance under the plans. We issue new shares of Microsoft common
stock to satisfy exercises and vesting of awards granted under all of our stock
plans.

Stock-based compensation expense and related income tax benefits were as
follows:

 

(In millions)                                                                                    
----------------------------------------------------------------------------------------------- -
                                                                                    
Year Ended June 30,                                            2013          2012          2011  
                                                                                    
Stock-based compensation expense                           $  2,406      $  2,244      $  2,166  
Income tax benefits related to stock-based compensation    $    842      $    785      $    758  


--------------------------------------------------------------------------------
Stock Plans (Excluding Stock Options)

Stock awards

Stock awards (“SAs”) are grants that entitle the holder to shares of Microsoft
common stock as the award vests. SAs generally vest over a five-year period.

Leadership stock awards

Leadership stock awards (“LSAs”) are a form of SAs in which the number of shares
ultimately received depends on our business performance against specified
performance metrics. LSAs replaced shared performance stock awards (“SPSA”) in
fiscal year 2013. Shares previously issued under the SPSA program will continue
to vest ratably under their original term, generally with a three-year remaining
service period.

A base number of LSAs are granted in each fiscal year, which represents the
performance period for the awards. Following the end of the performance period,
the number of shares can be increased by 25% if certain performance metrics are
met. One quarter of the awarded shares will vest one year after the grant date.
The remaining shares will vest semi-annually during the following three years.

Executive incentive plan

Under the Executive Incentive Plan (“EIP”), the Compensation Committee awards
performance-based compensation comprising both cash and SAs to executive
officers and certain senior executives. For executive officers, their awards are
based on an aggregate incentive pool equal to a percentage of consolidated
operating income. For fiscal years 2013, 2012, and 2011, the pool was 0.35%,
0.3%, and 0.25% of operating income, respectively. The SAs vest ratably in
August of each of the four years following the grant date. The final cash awards
will be determined after each performance period based on individual and
business performance.

 

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Activity for all stock plans

The fair value of each award was estimated on the date of grant using the
following assumptions:

 

--------------------------------------------------------------------------------
Year Ended June 30,                                       2013                 2012                 2011  
                                                                                      
Dividends per share (quarterly amounts)       $  0.20 - $ 0.23     $  0.16 - $ 0.20     $  0.13 - $ 0.16  
Interest rates range                               0.6% - 1.1%          0.7% - 1.7%          1.1% - 2.4%  


--------------------------------------------------------------------------------
During fiscal year 2013, the following activity occurred under our stock plans:

 

                                                                       Weighted 
                                                                        Average 
                                                                     Grant-Date 
                                                       Shares        Fair Value  
       ------------------------------------------------------------------------ -
                                                (In millions)                    
       
       Stock Awards                                                              
                                                                 
       Nonvested balance, beginning of year               281      $      23.91  
       Granted                                            104      $      28.37  
       Vested                                             (90 )    $      24.49  
       Forfeited                                          (22 )    $      25.10  
       ------------------------------------------------------ --                 
       Nonvested balance, end of year                     273      $      25.50  
                                              ---- ---------- --                 


As of June 30, 2013, there was approximately $5.0 billion of total unrecognized
compensation costs related to stock awards. These costs are expected to be
recognized over a weighted average period of 3 years.

During fiscal year 2012 and 2011, the following activity occurred under our
stock plans:

 

            (In millions, except fair values)            2012         2011  
            -------------------------------------------------------------- -
                                                   
            Stock Awards                                                    
                                                                
            Awards granted                                110          132  
            Weighted average grant-date fair value   $  24.60     $  22.22  


--------------------------------------------------------------------------------
Total vest-date fair value of stock awards vested was $2.8 billion, $2.4
billion, and $1.8 billion, for fiscal years 2013, 2012, and 2011, respectively.

Stock Options

Currently, we grant stock options primarily in conjunction with business
acquisitions. We granted two million, six million, and zero stock options in
conjunction with business acquisitions during fiscal years 2013, 2012, and 2011,
respectively.

Employee stock options activity during 2013 was as follows:

 

                                                                                        Weighted                     
                                                                                         Average                     
                                                                      Weighted         Remaining           Aggregate 
                                                                       Average       Contractual           Intrinsic 
                                                   Shares       Exercise Price              Term               Value  
-------------------------------------------------------------------------------------------------------------------- -
                                            (In millions)                                (Years)       (In millions)  
                                                                                                   
Balance, July 1, 2012                                  22      $         18.69                                        
Granted                                                 2      $          2.08                                        
Exercised                                             (19 )    $         19.26                                        
Canceled                                               (1 )    $         14.71                                        
--------------------------------------------------------- --                                                          
Balance, June 30, 2013                                  4      $          6.88              6.74     $            98  
Exercisable, June 30, 2013                              2      $          8.47              5.79     $            50  
-------------------------------------------------------------------------------------------------------------------- -


 

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As of June 30, 2013, approximately four million options that were granted in
conjunction with business acquisitions were outstanding. These options have an
exercise price range of $0.01 to $29.24 and a weighted average exercise price of
$7.33.

During the periods reported, the following stock option exercise activity
occurred:

 

   (In millions)                                                                        
   ----------------------------------------------------------------------------------- -
                                                                            
                                                        2013         2012         2011  
                                                                            
   Total intrinsic value of stock options exercised   $  197     $    456     $    222  
   Cash received from stock option exercises          $  382     $  1,410     $  1,954  
   Tax benefit realized from stock option exercises   $   69     $    160     $     77  
   ----------------------------------------------------------------------------------- -


Employee Stock Purchase Plan

We have an employee stock purchase plan (the “Plan”) for all eligible employees.
Shares of our common stock may be purchased by employees at three-month
intervals at 90% of the fair market value on the last trading day of each
three-month period. Employees may purchase shares having a value not exceeding
15% of their gross compensation during an offering period. Employees purchased
the following shares during the periods presented:

 

               (Shares in millions)                                          
               ------------------------------------------------------------ -
                                                                 
               Year Ended June 30,           2013         2012         2011  
                                                                 
               Shares purchased                20           20           20  
               Average price per share   $  26.81     $  25.03     $  22.98  
               ------------------------------------------------------------ -


At June 30, 2013, 191 million shares of our common stock were reserved for
future issuance through the Plan.

Savings Plan

We have a savings plan in the U.S. that qualifies under Section 401(k) of the
Internal Revenue Code, and a number of savings plans in international locations.
Participating U.S. employees may contribute up to 75% of their salary, but not
more than statutory limits. We contribute fifty cents for each dollar a
participant contributes in this plan, with a maximum contribution of 3% of a
participant’s earnings. Matching contributions for all plans were $393 million,
$373 million, and $282 million in fiscal years 2013, 2012, and 2011,
respectively, and were expensed as contributed. Matching contributions are
invested proportionate to each participant’s voluntary contributions in the
investment options provided under the plan. Investment options in the U.S. plan
include Microsoft common stock, but neither participant nor our matching
contributions are required to be invested in Microsoft common stock.

               NOTE 21 — SEGMENT INFORMATION AND GEOGRAPHIC DATA

In its operation of the business, management, including our chief operating
decision maker, the company’s Chief Executive Officer, reviews certain financial
information, including segmented internal profit and loss statements prepared on
a basis not consistent with U.S. GAAP. The segment information within this note
is reported on that basis. During the periods presented, our five segments were
Windows Division, Server and Tools, Online Services Division, Microsoft Business
Division, and Entertainment and Devices Division. During the three months ended
December 31, 2012, we changed the name of our Windows & Windows Live Division to
Windows Division.

Due to the integrated structure of our business, certain revenue earned and
costs incurred by one segment may benefit other segments. Revenue on certain
contracts may be allocated among the segments based on the relative value of the
underlying products and services. Costs that are identifiable are allocated to
the segments that benefit to incent cross-collaboration among our segments so
that one segment is not solely burdened by the cost of a mutually beneficial
activity. Allocated costs may include those relating to development and
marketing of products and services from which multiple segments benefit, or
those costs relating to services performed by one segment on behalf of other
segments. Each allocation is measured differently based on the specific facts
and circumstances of the costs being allocated.

 

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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: field selling; employee benefits; 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
other corporate-level activity is not allocated to our segments, including costs
of: broad-based sales and marketing; product support services; human resources;
legal; finance; information technology; corporate development and procurement
activities; research and development; legal settlements and contingencies; and
employee severance.

We have recast certain prior period amounts within this note to conform to the
way we internally managed and monitored segment performance during the current
fiscal year, reflecting immaterial movements of business activities between
segments and changes in cost allocations. In July 2013, we announced a change in
organizational structure as part of our transformation to a devices and services
company. As we evolve how we allocate resources and analyze performance in the
new structure, it is possible that our segments may change.

The principal products and services provided by each segment are summarized
below:

Windows Division – Windows Division offerings consist of the Windows operating
system, Surface, and PC accessories.

Server and Tools – Server and Tools product and service offerings include
Windows Server, Windows Azure, Microsoft SQL Server, Windows Intune, Windows
Embedded, Visual Studio, System Center products, and Enterprise Services.
Enterprise Services comprise Premier product support services and Microsoft
Consulting Services.

Online Services Division – Online Services Division offerings include Bing, Bing
Ads, and MSN.

Microsoft Business Division – Microsoft Business Division offerings include
Microsoft Office, Exchange, SharePoint, Lync, Yammer, Microsoft Dynamics
business solutions, and Office 365.

Entertainment and Devices Division – Entertainment and Devices Division
offerings include the Xbox 360 gaming and entertainment console, Kinect for Xbox
360, Xbox 360 video games, Xbox 360 accessories, Xbox LIVE, Skype, and Windows
Phone.

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

 

       (In millions)                                                                
       --------------------------------------------------------------------------- -
                                                                       
       Year Ended June 30,                       2013          2012           2011  
                                                                       
       Revenue                                                                      
                                                                       
       Windows Division                     $  18,680     $  18,844      $  18,815  
       Server and Tools                        20,295        18,544         16,571  
       Online Services Division                 3,284         2,935          2,680  
       Microsoft Business Division             24,738        24,082         22,407  
       Entertainment and Devices Division      10,213         9,590          8,896  
       Corporate and other                        639          (272 )          574  
       ---------------------------------------------- -   - ------- --   - ------- -
       Consolidated                         $  77,849     $  73,723      $  69,943  
                                            - ------- -   - ------- --   - ------- -


 

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      (In millions)                                                                  
      ---------------------------------------------------------------------------- --
                                                                       
      Year Ended June 30,                       2013           2012           2011   
                                                                       
      Operating Income (Loss)                                                        
                                                                       
      Windows Division                     $   8,943      $  12,005      $  12,040   
      Server and Tools                         8,152          7,256          6,132   
      Online Services Division                (1,298 )       (8,117 )       (2,649 ) 
      Microsoft Business Division             16,189         15,803         14,467   
      Entertainment and Devices Division         888            381          1,299   
      Corporate and other                     (6,110 )       (5,565 )       (4,128 ) 
      ---------------------------------------------- --   - ------- --   - ------- --
      Consolidated                         $  26,764      $  21,763      $  27,161   
                                           - ------- --   - ------- --   - ------- --


Reconciling amounts in the tables above and below include adjustments to conform
our internal accounting policies to U.S. GAAP and corporate-level activity not
specifically attributed to a segment. Significant internal accounting policies
that differ from U.S. GAAP relate to revenue recognition, income statement
classification, and depreciation.

Significant reconciling items were as follows:

 

      (In millions)                                                                  
      ---------------------------------------------------------------------------- --
                                                                      
      Year Ended June 30,                     2013            2012            2011   
                                                                      
      Corporate-level activity (a)      $   (6,665 )    $   (5,114 )    $   (4,506 ) 
      Revenue reconciling amounts (b)          400            (484 )           380   
      Other                                    155              33              (2 ) 
      -------------------------------------------- --   - -------- --   - -------- --
      Total                             $  (6,110)      $  (5,565)      $  (4,128)   
                                        - -------- --   - -------- --   - -------- --


 

(a) Corporate-level activity excludes revenue reconciling amounts presented      
    separately in that line item.                                                


(b) Revenue reconciling amounts for fiscal year 2012 and 2013 include the        
    deferral and subsequent recognition, respectively, of $540 million of revenue
    related to the Windows Upgrade Offer.                                        


No sales to an individual customer or country other than the United States
accounted for more than 10% of fiscal year 2013, 2012, or 2011 revenue. Revenue,
classified by the major geographic areas in which our customers are located, was
as follows:

 

               (In millions)                                                
               ----------------------------------------------------------- -
                                                               
               Year Ended June 30,        2013          2012          2011  
                                                               
               United States (a)     $  41,344     $  38,846     $  38,008  
               Other countries          36,505        34,877        31,935  
               ------------------------------- -   - ------- -   - ------- -
               Total                 $  77,849     $  73,723     $  69,943  
                                     - ------- -   - ------- -   - ------- -


 

(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 were as follows:

 

 (In millions)                                                                            
 --------------------------------------------------------------------------------------- -
                                                                             
 Year Ended June 30,                                    2013          2012          2011  
                                                                             
 Microsoft Office system                           $  22,995     $  22,299     $  20,730  
 Windows operating systems for computing devices      17,529        17,320        17,825  
 Server products and tools                            15,408        14,232        13,251  
 Xbox 360 platform                                     7,100         8,045         8,103  
 Consulting and product support services               4,372         3,976         3,372  
 Advertising                                           3,387         3,181         2,913  
 Other                                                 7,058         4,670         3,749  
 ----------------------------------------------------------- -   - ------- -   - ------- -
 Total                                             $  77,849     $  73,723     $  69,943  
                                                   - ------- -   - ------- -   - ------- -


 

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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, and 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.

Long-lived assets, excluding financial instruments and tax assets, classified by
the location of the controlling statutory company and with countries over 10% of
the total shown separately, were as follows:

 

                 (In millions)                                            
                 ------------------------------------------------------- -
                                                             
                 June 30,               2013          2012          2011  
                                                             
                 United States     $  16,615     $  14,081     $  18,498  
                 Luxembourg            6,943         6,975             0  
                 Other countries       4,171         3,835         2,989  
                 --------------------------- -   - ------- -   - ------- -
                 Total             $  27,729     $  24,891     $  21,487  
                                   - ------- -   - ------- -   - ------- -


                  NOTE 22 — QUARTERLY INFORMATION (UNAUDITED)

 

(In millions, except per                                                                                                       
share amounts)                                                                                                                      
------------------------------------------------------------------------------------------------------------------------------ -----
                                                                                                                 
Quarter Ended                     September 30          December 31         March 31             June 30                 Total      
                                                                                                                 
Fiscal Year 2013                                                                                                                    
                                                                                                                 
Revenue                         $       16,008        $      21,456        $  20,489           $  19,896             $  77,849      
Gross profit                            11,840               15,764           15,702              14,294                57,600      
Net income                               4,466                6,377            6,055  (a)          4,965  (b)           21,863  (c) 
Basic earnings per share                  0.53                 0.76             0.72                0.59                  2.61      
Diluted earnings per share                0.53                 0.76             0.72  (a)           0.59  (b)             2.58  (c) 
---------------------------------------------- --     -- ---------- --     - ------- -----     - ------- -------     - ------- -----
                                                                                                                 
Fiscal Year 2012                                                                                                                    
                                                                                                                 
Revenue                         $       17,372        $      20,885        $  17,407           $  18,059             $  73,723      
Gross profit                            13,595               15,247           13,455              13,896                56,193      
Net income                               5,738                6,624            5,108                (492 )  (d)        16,978  (d)  
Basic earnings (loss) per                                                                                                      
share                                     0.68                 0.79             0.61               (0.06 )                2.02      
Diluted earnings (loss) per                                                                                                    
share                                     0.68                 0.78             0.60               (0.06 )  (d)          2.00  (d)  


--------------------------------------------------------------------------------
 

(a) Includes a charge related to a fine imposed by the European Commission in    
    March 2013 which decreased net income by $733 million (€561 million) and     
    diluted earnings per share by $0.09.                                         


(b) Includes a charge for Surface RT inventory adjustments recorded in the fourth
    quarter of fiscal year 2013, which decreased net income by $596 million and  
    diluted earnings per share by $0.07.                                         


(c) Includes a charge related to a fine imposed by the European Commission in    
    March 2013 which decreased net income by $733 million (€561 million) and     
    diluted earnings per share by $0.09. Also includes a charge for Surface RT   
    inventory adjustments recorded in the fourth quarter of fiscal year 2013,    
    which decreased net income by $596 million and diluted earnings per share by 
    $0.07.                                                                       


(d) Includes a goodwill impairment charge related to our OSD business segment    
    which decreased net income by $6.2 billion and diluted earnings per share by 
    $0.73.                                                                       


 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Microsoft Corporation

Redmond, Washington

We have audited the accompanying consolidated balance sheets of Microsoft
Corporation and subsidiaries (the “Company”) as of June 30, 2013 and 2012, and
the related consolidated statements of income, comprehensive income, cash flows,
and stockholders’ equity for each of the three years in the period ended
June 30, 2013. These financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Microsoft Corporation and
subsidiaries as of June 30, 2013 and 2012, and the results of their operations
and their cash flows for each of the three years in the period ended June 30,
2013, in conformity with accounting principles generally accepted in the United
States of America.

We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the Company’s internal control over
financial reporting as of June 30, 2013, based on the criteria established in
Internal Control – Integrated Framework (1992) issued by the Committee of
Sponsoring Organizations of the Treadway Commission and our report dated
July 30, 2013, expressed an unqualified opinion on the Company’s internal
control over financial reporting.

/s/  DELOITTE & TOUCHE LLP

Seattle, Washington

July 30, 2013

 

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    ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
                              FINANCIAL DISCLOSURE

Not applicable.

                        ITEM 9A. 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.

REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate internal
control over financial reporting for the company. Internal control over
financial reporting is a process to provide reasonable assurance regarding the
reliability of our financial reporting for external purposes in accordance with
accounting principles generally accepted in the United States of America.
Internal control over financial reporting includes maintaining records that in
reasonable detail accurately and fairly reflect our transactions; providing
reasonable assurance that transactions are recorded as necessary for preparation
of our financial statements; providing reasonable assurance that receipts and
expenditures of company assets are made in accordance with management
authorization; and providing reasonable assurance that unauthorized acquisition,
use or disposition of company assets that could have a material effect on our
financial statements would be prevented or detected on a timely basis. Because
of its inherent limitations, internal control over financial reporting is not
intended to provide absolute assurance that a misstatement of our financial
statements would be prevented or detected.

Management conducted an evaluation of the effectiveness of our internal control
over financial reporting based on the framework in Internal Control – Integrated
Framework (1992) issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this evaluation, management concluded that the
company’s internal control over financial reporting was effective as of June 30,
2013. There were no changes in our internal control over financial reporting
during the quarter ended June 30, 2013 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting. Deloitte & Touche LLP has audited our internal control over financial
reporting as of June 30, 2013; their report is included in Item 9A.

 

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                                    PART II

                                    Item 9A

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Microsoft Corporation

Redmond, Washington

We have audited the internal control over financial reporting of Microsoft
Corporation and subsidiaries (the “Company”) as of June 30, 2013, based on
criteria established in Internal Control – Integrated Framework (1992) issued by
the Committee of Sponsoring Organizations of the Treadway Commission. The
Company’s management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting, included in the accompanying Report of
Management on Internal Control Over Financial Reporting. Our responsibility is
to express an opinion on the Company’s internal control over financial reporting
based on our audit.

We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.

A company’s internal control over financial reporting is a process designed by,
or under the supervision of, the company’s principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company’s board of directors, management, and other personnel 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. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of June 30, 2013, based on the
criteria established in Internal Control – Integrated Framework (1992) issued by
the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements as of and for the year ended June 30, 2013, of the Company and our
report dated July 30, 2013, expressed an unqualified opinion on those financial
statements.

/s/  DELOITTE & TOUCHE LLP

Seattle, Washington

July 30, 2013

 

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                                  PART II, III

                          Item 9B, 10, 11, 12, 13, 14

 

                           ITEM 9B. OTHER INFORMATION

Not applicable.

                                    PART III

        ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

A list of our executive officers and biographical information appears in Part I,
Item 1 of this Form 10-K. Information about our directors may be found under the
caption “Our Director Nominees” in our Proxy Statement for the Annual Meeting of
Shareholders to be held November 19, 2013 (the “Proxy Statement”). Information
about our Audit Committee may be found under the caption “Board Committees” in
the Proxy Statement. That information is incorporated herein by reference.

The information in the Proxy Statement set forth under the caption “Section
16(a) Beneficial Ownership Reporting Compliance” is incorporated herein by
reference.

We have adopted the Microsoft Finance Code of Professional Conduct (the “finance
code of ethics”), a code of ethics that applies to our Chief Executive Officer,
Chief Financial Officer, Chief Accounting Officer and Corporate Controller, and
other finance organization employees. The finance code of ethics is publicly
available on our website at www.microsoft.com/investor/MSFinanceCode. If we make
any substantive amendments to the finance code of ethics or grant any waiver,
including any implicit waiver, from a provision of the code to our Chief
Executive Officer, Chief Financial Officer, or Chief Accounting Officer and
Corporate Controller, we will disclose the nature of the amendment or waiver on
that website or in a report on Form 8-K.

                        ITEM 11. EXECUTIVE COMPENSATION

The information in the Proxy Statement set forth under the captions “Director
Compensation,” “Named Executive Officer Compensation,” “Compensation Committee
Interlocks and Insider Participation,” and “Compensation Committee Report” is
incorporated herein by reference.

  ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
                          RELATED STOCKHOLDER MATTERS

The information in the Proxy Statement set forth under the captions “Information
Regarding Beneficial Ownership of Principal Shareholders, Directors, and
Management” and “Equity Compensation Plan Information” is incorporated herein by
reference.

          ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
                             DIRECTOR INDEPENDENCE

The information set forth in the Proxy Statement under the captions “Director
Independence” and “Certain Relationships and Related Transactions” is
incorporated herein by reference.

                ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

Information concerning principal accountant fees and services appears in the
Proxy Statement under the headings “Fees Billed by Deloitte & Touche” and
“Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit
Services of Independent Auditor” and is incorporated herein by reference.

 

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                                    PART IV

                                    Item 15

 

                                    PART IV

              ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a) Financial Statements and Schedules


The financial statements are set forth under Item 8 of this Form 10-K, as
indexed below. Financial statement schedules have been omitted since they either
are not required, not applicable, or the information is otherwise included.

 

       Index to Financial Statements                                  Page  
       ------------------------------------------------------------------- -
                                                                   
         Income Statements                                              49  
                                                                   
         Comprehensive Income Statements                                50  
                                                                   
         Balance Sheets                                                 51  
                                                                   
         Cash Flows Statements                                          52  
                                                                   
         Stockholders’ Equity Statements                                53  
                                                                   
         Notes to Financial Statements                                  54  
                                                                   
         Report of Independent Registered Public Accounting Firm        89  


 

(b) Exhibit Listing


 

                                                                      Incorporated by Reference                 
Exhibit                                       Filed                     Period                                 
Number      Exhibit Description              Herewith      Form         Ending       Exhibit       Filing Date  
                                                                                               
3.1         Amended and Restated Articles                  10-Q       12/31/09           3.1           1/28/10  
            of Incorporation of Microsoft                                                                      
            Corporation                                                                                        
                                                                                               
3.2         Bylaws of Microsoft                             8-K                          3.2           6/18/12  
            Corporation                                                                                        
                                                                                               
4.1         Form of Indenture between                     3-ASR                          4.1          11/20/08  
            Microsoft Corporation and The                                                                      
            Bank of New York Mellon Trust                                                                      
            Company, N.A., as Trustee                                                                          
            (“Base Indenture”)                                                                                 
                                                                                               
4.2         Form of First Supplemental                      8-K                          4.2           5/15/09  
            Indenture for 2.95% Notes due                                                                      
            2014, 4.20% Notes due 2019,                                                                        
            and 5.20% Notes due 2039,                                                                          
            dated as of May 18, 2009,                                                                          
            between Microsoft Corporation                                                                      
            and The Bank of New York                                                                           
            Mellon Trust Company, N.A., as                                                                     
            Trustee, to the Base Indenture                                                                     
                                                                                               
4.5         Form of Second Supplemental                     8-K                          4.5           9/27/10  
            Indenture for 0.875% Notes due                                                                     
            2013, 1.625% Notes due 2015,                                                                       
            3.00% Notes due 2020, and                                                                          
            4.50% Notes due 2040, dated as                                                                     
            of September 27, 2010, between                                                                     
            Microsoft Corporation and The                                                                      
            Bank of New York Mellon Trust                                                                      
            Company, N.A., as Trustee, to                                                                      
            the Indenture, dated as of                                                                         
            May 18, 2009, between                                                                              
            Microsoft Corporation and The                                                                      
            Bank of New York Mellon Trust                                                                      
            Company, N.A., as Trustee                                                                          


 

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                                    PART IV

                                    Item 15

 

                                                                         Incorporated by Reference                 
Exhibit                                        Filed                      Period                                  
Number     Exhibit Description                Herewith      Form          Ending       Exhibit        Filing Date  
                                                                                                 
4.6        Third Supplemental Indenture                      8-K                           4.6             2/8/11  
           for 2.500% Notes due 2016,                                                                             
           4.000% Notes due 2021, and                                                                             
           5.300% Notes due 2041, dated as                                                                        
           of February 8, 2011, between                                                                           
           Microsoft Corporation and The                                                                          
           Bank of New York Mellon Trust                                                                          
           Company, N.A., as Trustee, to                                                                          
           the Indenture, dated as of                                                                             
           May 18, 2009, between Microsoft                                                                        
           Corporation and The Bank of New                                                                        
           York Mellon Trust Company,                                                                             
           N.A., as Trustee                                                                                       
                                                                                                 
4.7        Fourth Supplemental Indenture                     8-K                           4.7            11/7/12  
           for 0.875% Notes due 2017,                                                                             
           2.125% Notes due 2022, and                                                                             
           3.500% Notes due 2042, dated as                                                                        
           of November 7, 2012, between                                                                           
           Microsoft Corporation and The                                                                          
           Bank of New York Mellon Trust                                                                          
           Company, N.A., as Trustee, to                                                                          
           the Indenture, dated as of May                                                                         
           18, 2009, between Microsoft                                                                            
           Corporation and The Bank of New                                                                        
           York Mellon Trust Company,                                                                             
           N.A., as Trustee                                                                                       
                                                                                                 
10.1*      Microsoft Corporation 2001                       10-Q        12/31/11          10.1            1/19/12  
           Stock Plan                                                                                             
                                                                                                 
10.3*      Microsoft Corporation 1999                        8-K                          10.3           11/15/04  
           Stock Plan for Non-Employee                                                                            
           Directors                                                                                              
                                                                                                 
10.4*      Microsoft Corporation Employee                   10-K         6/30/12          10.4            7/26/12  
           Stock Purchase Plan                                                                                    
                                                                                                 
10.5*      Microsoft Corporation Deferred                   10-Q         3/31/12          10.5            4/19/12  
           Compensation Plan                                                                                      
                                                                                                 
10.6*      Form of Stock Award Agreement                    10-K                          10.8            8/25/06  
           under the Microsoft Corporation                                                                        
           2001 Stock Plan                                                                                        
                                                                                                 
10.7*      Form of Stock Award Agreement                    10-K         6/30/04          10.9             9/1/04  
           for Non-Employee Directors                                                                             
           under the Microsoft Corporation                                                                        
           1999 Stock Plan for                                                                                    
           Non-Employee Directors                                                                                 
                                                                                                 
10.10*     Form of Stock Option Agreement                   10-K         6/30/04         10.12             9/1/04  
           under the Microsoft Corporation                                                                        
           2001 Stock Plan                                                                                        
                                                                                                 
10.11*     Form of Stock Option Agreement                   10-K         6/30/04         10.13             9/1/04  
           for Non-Employee Directors                                                                             
           under the 1999 Stock Plan for                                                                          
           Non-Employee Directors                                                                                 
                                                                                                 
10.12      2009 Officers’ Indemnification                   10-K         6/30/10         10.12            7/30/10  
           Trust Agreement between                                                                                
           Microsoft Corporation and The                                                                          
           Bank of New York Mellon Trust                                                                          
           Company, as trustee                                                                                    
                                                                                                 
10.13      Amended and Restated 2003                        10-K         6/30/10         10.13            7/30/10  
           Indemnification Trust Agreement                                                                        
           between Microsoft Corporation                                                                          
           and The Bank of New York Mellon                                                                        
           Trust Company, as trustee                                                                              
                                                                                                 
10.14*     Microsoft Corporation Deferred                    S-8                          99.2            2/28/06  
           Compensation Plan for                                                                                  
           Non-Employee Directors                                                                                 


 

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                                    PART IV

                                    Item 15

 

                                                                          Incorporated by Reference               
Exhibit                                          Filed                     Period                                
Number    Exhibit Description                  Herewith        Form        Ending      Exhibit       Filing Date  
                                                                                                 
10.17*    Executive Officer Incentive Plan                     10-Q       9/30/08        10.17          10/23/08  
                                                                                                 
10.18*    Form of Executive Incentive Plan                     10-Q       9/30/12        10.18          10/18/12  
          Stock Award Agreement under the                                                                        
          Microsoft Corporation 2001 Stock                                                                       
          Plan                                                                                                   
                                                                                                 
10.19*    Resignation Agreement and Full and           X                                                          
          Final Release of Claims between                                                                        
          Microsoft Corporation and Steven                                                                       
          Sinofsky                                                                                               
                                                                                                 
12        Computation of Ratio of Earnings             X                                                          
          to Fixed Charges                                                                                       
                                                                                                 
21        Subsidiaries of Registrant                   X                                                          
                                                                                                 
23.1      Consent of Independent Registered            X                                                          
          Public Accounting Firm                                                                                 
                                                                                                 
31.1      Certifications of Chief Executive            X                                                          
          Officer Pursuant to Section 302 of                                                                     
          the Sarbanes-Oxley Act of 2002                                                                         
                                                                                                 
31.2      Certifications of Chief Financial            X                                                          
          Officer Pursuant to Section 302 of                                                                     
          the Sarbanes-Oxley Act of 2002                                                                         
                                                                                                 
32.1**    Certifications of Chief Executive            X                                                          
          Officer Pursuant to Section 906 of                                                                     
          the Sarbanes-Oxley Act of 2002                                                                         
                                                                                                 
32.2**    Certifications of Chief Financial            X                                                          
          Officer Pursuant to Section 906 of                                                                     
          the Sarbanes-Oxley Act of 2002                                                                         
                                                                                                 
101.INS   XBRL Instance Document                       X                                                          
                                                                                                 
101.SCH   XBRL Taxonomy Extension Schema               X                                                          
                                                                                                 
101.CAL   XBRL Taxonomy Extension                      X                                                          
          Calculation Linkbase                                                                                   
                                                                                                 
101.DEF   XBRL Taxonomy Extension Definition           X                                                          
          Linkbase                                                                                               
                                                                                                 
101.LAB   XBRL Taxonomy Extension Label                X                                                          
          Linkbase                                                                                               
                                                                                                 
101.PRE   XBRL Taxonomy Extension                      X                                                          
          Presentation Linkbase                                                                                  


 

* Indicates a management contract or compensatory plan or arrangement


** Furnished, not filed


 

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                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Redmond,
State of Washington, on July 30, 2013.

 

MICROSOFT CORPORATION                                  

/S/  FRANK H. BROD                                     
Frank H. Brod                                          
Corporate Vice President, Finance and Administration;  
Chief Accounting Officer (Principal Accounting Officer)


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of Registrant and in
the capacities indicated on July 30, 2013.

 

Signature                                  Title                                
--------------------------------------------------------------------------------
                                         
/S/  WILLIAM H. GATESIII                   Chairman                             
----------------------------------------   
William H. Gates III                       
                                         
/S/  STEVEN A. BALLMER                     Director and Chief Executive Officer 
----------------------------------------   
Steven A. Ballmer                          
                                         
/S/  DINADUBLON                            Director                             
----------------------------------------   
Dina Dublon                                
                                         
/S/  MARIAKLAWE                            Director                             
----------------------------------------   
Maria Klawe                                
                                         
/S/  STEPHEN J. LUCZO                      Director                             
----------------------------------------   
Stephen J. Luczo                           
                                         
/S/  DAVID F. MARQUARDT                    Director                             
----------------------------------------   
David F. Marquardt                         
                                         
/S/  CHARLES H. NOSKI                      Director                             
----------------------------------------   
Charles H. Noski                           
                                         
/S/  HELMUTPANKE                           Director                             
----------------------------------------   
Helmut Panke                               
                                         
/S/  JOHN W. THOMPSON                      Director                             
----------------------------------------   
John Thompson                              
                                         
/S/  AMY E. HOOD                           Executive Vice President and Chief   
----------------------------------------   Financial Officer                    
Amy E. Hood                                (Principal Financial Officer)        
                                         
/S/  FRANK H. BROD                         Corporate Vice President, Finance and
----------------------------------------   Administration;                      
Frank H. Brod                              Chief Accounting Officer             
                                           (Principal Accounting Officer)       


 

                                       96




EX-10.19
2
d527745dex1019.htm
RESIGNATION AGREEMENT BETWEEN MICROSOFT CORPORATION AND STEVEN SINOFSKY


                                                                   Exhibit 10.19

           RETIREMENT AGREEMENT AND FULL AND FINAL RELEASE OF CLAIMS

1. Steven Sinofsky resigned from his employment with Microsoft Corporation
(“Microsoft”), effective December 31, 2012 (“Separation Date”). We wish to agree
on the consideration described in Paragraph 2 below, to which he would not be
otherwise entitled, and in exchange for that consideration we have chosen to
sign this Retirement Agreement and Full and Final Release of Claims
(“Agreement”). Steven acknowledges that his execution of this Agreement is
knowing and voluntary and that he has had a reasonable period of time in which
to consider whether to sign this Agreement. No coercion or undue influence has
been exerted on him to execute this Agreement.

2. Consideration. In exchange for his compliance with this Agreement and
Sections 2, 3 and 6 of the Microsoft Corporation Employee Non-Disclosure
Agreement (hereafter “Employee Agreement,” attached hereto as Exhibit A), and
honoring the commitments undertaken in this Agreement, Microsoft agrees to pay
Steven the value (i) of the shares of stock that would have vested and become
payable under his Company stock awards with grant numbers 0000000811105,
0000001087120, 0000001180497, and 0000001299366 in connection with a qualifying
“retirement” under the stock award agreements for the stock awards on the
Separation Date; and (ii) in recognition of his half year employment in fiscal
year 2013, 50% of the shares of stock that would have vested and become payable
under the Company stock award with grant number 0000001299375 (collectively, the
“Stock Awards,”), all based on the vesting schedule that would have applied in
connection with a qualifying “retirement” on his separation date under his Stock
Awards. Exhibit B conclusively sets forth the shares of stock subject to this
Agreement and the applicable vesting dates therefor. Payment will be (A) in
cash, (B) made within fifteen (15) days following each vesting date under the
stock awards, (C) calculated by multiplying the number of shares that vest by
the closing price of Microsoft common stock as reported on Nasdaq.com on the
last open market trading day preceding the vesting date, and (D) reduced by
required taxes and withholding. Steven understands and agrees that, in order to
be eligible for the payments described in this Paragraph 2, he will be required
to sign and provide to Microsoft a written certification (in the form attached
hereto as Exhibit C) that he has complied with the terms of this agreement in
all material respects, at least five (5) business days before the payment date.
Microsoft agrees that it shall make these payments and provide these benefits
unless Steven materially breaches this Agreement and fails to cure such breach
within ten (10) days of written notice from Microsoft of such breach.

3. Employee Agreement, Noncompetition and Nonsolicitation. Steven understands
that Sections 2, 3 and 6 of the Employee Agreement remains fully binding and
enforceable according to their terms (the “Continuing Obligations”). Microsoft
acknowledges and agrees that, other than the Continuing Obligations, the
Employee Agreement is terminated and has no further force or effect. In addition
to the Continuing Obligations, Steven agrees that he will not for a period of
twelve (12) months after the Separation Date (a) accept direct or indirect
employment with the following companies, Amazon, Apple, EMC, Facebook, Google,
Oracle, VMWare; (b) directly or indirectly communicate with any client or
customer of Microsoft or its subsidiaries listed on Exhibit D for the purpose of
encouraging such client or customer to cease doing business with Microsoft or
(c) intentionally do any of the following: encourage, induce, attempt to induce
or assist another to induce or attempt to induce any person employed by
Microsoft or by one of Microsoft’s subsidiaries to terminate his or her
employment with Microsoft or its subsidiary or to work for any entity other than
Microsoft or its subsidiary or interfere with the relationship between Microsoft
and any officer thereof. For the sake of clarity, clause (c) shall not be
violated if an employee of Microsoft is employed by an entity with which Steven
is associated so long as he did not engage in activities described in clause
(c).

Steven has returned to Microsoft his Microsoft cardkey(s), corporate American
Express card and phone card, if any, and any other Microsoft Property in his
possession or control, including but not limited to hardware, software, source
code, patent applications, budgets, personnel files, financial or marketing
data, status reports, customer lists, customer contact information, personnel
data, and any other proprietary or confidential data, documents and materials in
any form or media (collectively, “Microsoft Property”). He has also agreed to
permanently delete all Microsoft Property from any non-Microsoft computer,
electronic device, storage device, storage system, or storage service that is in
his possession or under his control, including (without limitation) desktop and
laptop computers, mobile telephones, tablet devices, memory sticks, disks, and
hard drives. He acknowledges and

 

                                       1

--------------------------------------------------------------------------------
agrees that nothing in this Agreement is intended to, nor shall it, relieve him
of any obligation he has under Sections 2, 3 and 6 the Employee Agreement.
Anything to the contrary notwithstanding, nothing in this Agreement shall
prevent Steven from retaining a home computer and security system, papers and
other materials of a personal nature, including personal diaries, calendars and
Rolodexes, information relating to his compensation or relating to reimbursement
of expenses, agreements relating to his employment, and information that he
reasonably believes may be needed for tax purposes. He also shall be permitted
to retain copies of plans and programs relating to his employment that do not
contain Microsoft confidential information.

4. Cooperation. For the four (4) year period following the separation date,
Steven agrees that, upon reasonable request, he will reasonably cooperate with
Microsoft, its subsidiaries and affiliates, and any of their officers,
directors, agents, employees, attorneys and advisors in Microsoft’s
investigation of, preparation for, and prosecution or defense of any matter(s)
brought by or against Microsoft or any Released Party with respect to litigation
concerning: (a) facts or circumstances about which he has any actual or alleged
knowledge or expertise that was obtained during his employment with Microsoft;
or (b) any of his acts or omissions, real or alleged, of his employment with
Microsoft. Steven agrees that, upon reasonable notice, he will appear and
provide full and truthful testimony in proceedings associated with the above
referenced matters, provided that Microsoft shall reimburse him for all
reasonable travel expenses (on a basis consistent with senior executive officers
of Microsoft) associated with the giving of testimony and shall work with him as
practicable to schedule the activities contemplated by this paragraph so as not
to unreasonably interfere with his other personal or professional commitments.
Microsoft agrees to defend, indemnify, and hold him harmless from and against
all Claims to the extent that the Claims arise out of or relate to any of his
acts or omissions, real or alleged, during his employment with Microsoft or in
connection with his services under this Paragraph 4, except as prohibited by
law.

5. Release of Claims. Steven hereby agrees, that on behalf of himself and his
marital community, heirs, executors, successors and assigns, to release (i.e.,
give up) all known and unknown claims that he currently has against any of the
Released Parties. For purposes of this Agreement, the Released Parties means:
Microsoft and any of its current and former parents, subsidiaries, affiliates,
related companies, joint ventures, their predecessors and successors, and with
respect to each such entity, all of its past, present and future officers,
directors, agents, shareholders, administrators, representatives, employees,
attorneys, insurers, successor or assigns, each in his/her capacity as such.
Steven understands and agrees that this release includes, but is not limited to,
any and all claims or causes of action arising under:

 

    (a) Any federal law relating to employment discrimination, termination of     
        employment, benefits, wages, reasonable accommodation, or rights of       
        disabled employees, such as the Age Discrimination in Employment          
        Act of 1967, 29 U.S.C. § 621 et seq., the Americans with Disabilities Act,
        the Equal Pay Act, the Fair Labor Standards Act, the Family and Medical   
        Leave Act, Title VII of the 1964 Civil Rights Act, the Employee Retirement
        Income Security Act of 1974, and the Worker Adjustment and Retraining     
        Notification Act.                                                         


 

    (b) Any state, local or foreign law relating to employment discrimination,    
        termination of employment, benefits, wages, reasonable accommodation, or  
        rights of disabled employees, including, but not limited to, the          
        Washington Law against Discrimination.                                    


 

    (c) Any other basis for legal or equitable relief whether based on express or 
        implied contract, tort, statute, regulation, ordinance, common law, or    
        other legal or equitable ground.                                          


Steven agrees that this Agreement is not an admission of guilt or wrongdoing by
the Released Parties and acknowledges that the Released Parties do not believe
or admit that they have done anything wrong. Steven understands that he is not
waiving any (i) claims that the law does not permit him to waive, (ii) claims
arising from events occurring after the date he signs this Agreement,
(iii) claims for indemnification, contribution or for D&O coverage or
(iv) claims for accrued benefits or compensation (except for claims pertaining
to any awarded but unvested stock awards). Steven represents that he has not
filed or caused to be filed any lawsuit, complaint, or charge against Microsoft
or any of the Released Parties with respect to any claim this Agreement purports
to waive with any governmental agency or in any court, and that he will not
file, cause to file, initiate, or pursue (except as otherwise provided in this
Agreement or required by law) any such complaints, charges, or lawsuits at any
time hereafter other than to enforce his rights under this Agreement.

 

                                       2

--------------------------------------------------------------------------------
Microsoft, on its behalf and on behalf of each Released Party in their capacity
as such, hereby releases all known claims any of them have against Steven,
excluding any claim related to fraud or misappropriation of Microsoft property.

6. Confidentiality and Non-Disparagement.

(a) Steven agree to keep all details of this Agreement and the details
surrounding his separation in strict confidence except that he may make
disclosures as follows: (1) to his immediate family; (2) to his financial and
legal advisors who have a reasonable need to know this information; (3) to the
extent he is compelled by subpoena or other legal process to disclose such
information; or (4) to the extent reasonably required in order to prosecute or
defend any action for breach of this Agreement. Steve agrees that if he does
share this Agreement or any information in it with any of the aforementioned
individuals, he will instruct such person(s) that the information is strictly
confidential and that they may not share it with anyone else. The Parties agree
that, to the extent that Microsoft discloses the terms of the Agreement in any
filing with the Securities & Exchange Commission pursuant to the applicable
securities laws and regulations, the foregoing obligation to maintain the
confidentiality of the terms of this Agreement ceases with respect to the
information disclosed in the filing.

(b) Steven agrees not to make any disparaging remarks about Microsoft, its
officers or directors, its products, or the Released Parties, including but not
limited to disparaging statements relating to his employment with or separation
from Microsoft; provided that commencing January 1, 2016, this clause (b) shall
not be violated by statements or communications (in any medium) that (i) do not
rely on confidential information obtained by Steven during his employment at
Microsoft and (ii) are made directly or indirectly by Steven (A) regarding
Microsoft products, services, or business practices or decisions that are
created, rendered or implemented after January 1, 2016 or (B) regarding
Microsoft products or services made after January 1, 2014 and that are made in
connection with, related to or during the course of Steven’s employment,
engagement or other relationship with another business organization.

(c) Microsoft agrees that it and its directors and members of the company’s
Senior Leadership Team (or any successor team thereto) will not make any
disparaging remarks about him, including but not limited to disparaging
statements relating to Steven’s employment with or separation from Microsoft.

Notwithstanding the foregoing, nothing in this Paragraph 6 shall prevent any
person from:

(i) responding publicly to any incorrect, disparaging or derogatory public
statement to the extent reasonably necessary to correct or refute such public
statement, or

(ii) making any truthful statement to the extent:

(x) necessary with respect to any litigation, arbitration or mediation involving
this Agreement, including, but not limited to, the enforcement of this
Agreement, or

(y) required by law or by any court, arbitrator, mediator or administrative of
legislative body (including any committee thereof) with actual or apparent
jurisdiction to order such person to disclose or make accessible such
information.

7. No Assistance. Steven agrees not to provide assistance to any current or
former Microsoft employee to initiate, pursue, or raise any complaints,
concerns, claims, or litigation of any kind against the Released Parties, unless
compelled to do so by a valid subpoena or court order. If compelled to testify
or otherwise provide evidence in any proceeding, he will provide Microsoft with
reasonably prompt notice of receipt of an order or other demand for his
participation by giving notice to Brad Smith, General Counsel, Microsoft
Corporation, One Microsoft Way, Redmond, WA 98052, in sufficient time for
Microsoft to oppose such testimony or participation. To the extent prohibited by
law, this paragraph does not prevent him from participating in government
investigations.

8. Future Employment. Steven understands and agrees that, as a condition of
receiving the consideration described in Paragraph 2, he will not be entitled to
any future employment with Microsoft or any subsidiary, joint venture, or
affiliate of Microsoft in which Microsoft owns an interest of 50 percent or more
(collectively, “Microsoft or its Affiliates”). He further agrees that he will
not apply for, or otherwise seek future employment by Microsoft or its
Affiliates, and that he will not institute or join any action, lawsuit or
proceeding against Microsoft or its Affiliates for any failure to employ him.

 

                                       3

--------------------------------------------------------------------------------
9. Entire Agreement. Microsoft and Steven acknowledge and agree that this
Agreement contains the entire agreement of Microsoft and him as to matters
addressed in it except as set forth in Paragraph 3 and that it merges any and
all prior written and oral communications concerning those matters. Other than
what is expressly stated in this Agreement, no different or additional promises
or representations of any kind have been made to induce him to sign this
Agreement, which he signs freely and in the absence of any coercion or duress
whatsoever. Steven understands that the terms of this Agreement may not be
modified, amended or superseded except by a subsequent written agreement signed
by his self and the undersigned Microsoft representative.

10. Withholding of money owed. Except as would constitute an impermissible
offset for purposes of Section 409A of the Internal Revenue Code, he authorizes
Microsoft to withhold from any monies owed to him by Microsoft as of the
Separation Date, via payroll deductions, any and all monies due to Microsoft
from him, including without limitation cash and travel advances, amounts due the
Company Store, employee benefit plan deductions, other advances and any unpaid
credit or phone card charges. He understands that any such payroll deductions
are for his convenience and for his full benefit.

11. Governing Law and Dispute Resolution.

(a) The Parties agree that the laws of the State of Washington will govern in
any action brought by either himself or Microsoft to interpret or enforce the
terms of this Agreement, without regard to principles of conflicts of laws that
would call for the application of the substantive law of any jurisdiction other
than the State of Washington.

(b) The Parties further agree that any dispute arising in connection with the
execution and/or operation of this Agreement or the Employee Agreement shall be
resolved in the following manner unless otherwise agreed to by the Parties.

 

    (1) The Parties agree to first attempt to resolve all disputes through        
        informal negotiations. The Party contending there is a breach or other    
        issue arising from or related to this Agreement shall provide written     
        notice to the other Party describing with specific the nature of the      
        breach of other issue. Within five (5) days after delivery of the written 
        notice, the other Party shall respond in writing stating its position.    


 

    (2) If the Parties are unable to resolve the dispute through informal         
        negotiations, the Parties agree to resolve all disputes by binding        
        arbitration before a qualified mutually selected arbitrator. The Party    
        initiating the arbitration shall bear the burden of proof of breach and   
        actual damages; provided, however, that no actual damages need to be      
        proven for the arbitrator to award the liquidated damages provided for in 
        this Agreement. The arbitrator shall issue a written decision within      
        fifteen (15) days of the end of the hearing. The decision of the          
        arbitrator shall be final and binding and may be enforced and a judgment  
        entered in any court of competent jurisdiction. The arbitration itself,   
        and all testimony, documents, briefs, and arguments therein, shall be kept
        confidential, except to the extent described in the exceptions listed in  
        clauses (1) through (4) of Paragraph 6(a) above.                          


 

    (3) Notwithstanding the foregoing agreements in subparagraphs (1) and (2) of  
        this section, the Parties agree that breach of the confidentiality and    
        non-disparagement provisions set forth in Paragraph 6 could cause         
        irreparable injury to the other party and that such other party will have 
        the right to seek immediate injunctive relief or other equitable relief   
        enjoining any threatened or actual breach in a court in King County or the
        Western District of Washington.                                           


12. Current Address. Through the fourth anniversary of the Separation Date,
Steven agrees to provide Brad Smith, General Counsel, Microsoft Corporation, One
Microsoft Way, Redmond, WA 98052, with his current home address and telephone
number.

13. Severability. The provisions of this Agreement are severable, and if any
part of this Agreement is found to be unenforceable (with the exception of the
noncompetition and nonsolicitation obligations set forth in Paragraph 3 and the
Release contained in Paragraph 5), the remainder of this Agreement will remain
fully valid and enforceable. To the extent any terms of this Agreement are
called into question, all provisions shall be interpreted in a manner that would
make them consistent with current law.

 

                                       4

--------------------------------------------------------------------------------
14. Consideration Period. In compliance with the terms of the Age Discrimination
in Employment Act and the Older Workers Benefit Protection Act, Steven expressly
acknowledges that he have been given twenty-one (21) days to review this
Agreement before signing it. He also understands that he may revoke this
Agreement for a period of seven (7) days following his signature of it and will
send such revocation in writing postmarked within the seven-day period to Brad
Smith, and that it is not effective or enforceable until that seven-day
revocation period has expired. He understands that he may sign this Agreement
before the end of the 21-day consideration period but may not be required to do
so. Steven fully understands that if he signs this Agreement prior to expiration
of the 21-day consideration period, he will be waiving his right to the
remainder of the 21-day consideration period. Steven understand that he was
advised to seek legal counsel prior to signing this Agreement. The Effective
Date of this Agreement shall be the day following expiration of the seven-day
revocation period.

Employee acknowledgment

I ACKNOWLEDGE THAT I HAVE CAREFULLY READ AND HAVE VOLUNTARILY SIGNED THIS
AGREEMENT AND RELEASE, THAT I FULLY UNDERSTAND ITS FINAL AND BINDING EFFECT,
THAT BY SIGNING I INTENDED TO FULLY AND FINALLY RELEASE ANY AND ALL CLAIMS I MAY
HAVE AGAINST MICROSOFT AND THE OTHER RELEASED PARTIES DESCRIBED IN PARAGRAPH 5
ABOVE, AND THAT, PRIOR TO SIGNING THIS AGREEMENT AND RELEASE, I HAVE BEEN
ADVISED OF MY RIGHT TO CONSULT, AND HAVE BEEN GIVEN ADEQUATE TIME TO REVIEW HIS
LEGAL RIGHTS WITH AN ATTORNEY OF MY CHOICE.

 

                                       5

--------------------------------------------------------------------------------
EMPLOYEE:                                                                                                                                                     
                                                                                                                                                            
/S/ STEVEN SINOFSKY                                                                                                       June 17, 2013                       
Steven Sinofsky                                                                                                           Date                                
                                                                                                                                                            
MICROSOFT CORPORATION:                                                                                                                                        
                                                                                                                                                            
By     /S/ BRADFORD L. SMITH                                                                                              June 21, 2013                       
      Bradford L. Smith, Executive Vice President and General Counsel         Date                                                                                                             


 

     Exhibits:   A – Microsoft Corporation Employee Non-Disclosure Agreement
                 B – Stock Award Payment Schedule                           
                 C – Form of Certification                                  
                 D – Client/Customer List                                   


 

                                       6

--------------------------------------------------------------------------------
                                   EXHIBIT A

                             Microsoft Corporation

                       Employee Non-Disclosure Agreement

1. As an employee of MICROSOFT CORPORATION, a Delaware corporation
(“MICROSOFT”), and in consideration of the compensation now and hereafter paid
to me, I will devote my best efforts to furthering the best interests of
MICROSOFT. During my employment I will not engage in any activity or investment
(other than an investment of less than .01% of the shares of a company traded on
registered stock exchange), that (a) conflicts with MICROSOFT’s business
interests, including without limitation, any business activity not contemplated
by this Agreement, (b) occupies my attention so as to interfere with the proper
and efficient performance of my duties at MICROSOFT, or (c) interferes with the
independent exercise of my judgment in MICROSOFT’s best interests. As used
herein, MICROSOFT’s “business” means the development, marketing and support of
software for business and professional use, including operating systems,
languages and applications programs as well as books and hardware for the
microcomputer marketplace.

2. At times during my employment and thereafter, I will not disclose to anyone
outside MICROSOFT nor use for any purpose other than my work for MICROSOFT a)
any confidential or proprietary technical, financial, marketing, manufacturing
or distribution or other technical or business information or trade secrets of
MICROSOFT, including without limitation, concepts, techniques, processes,
methods, systems, designs, circuits, cost data, computer programs, formulas,
development or experimental work, work in progress, customers and suppliers, b)
any information MICROSOFT has received from others which MICROSOFT is obligated
to treat as confidential or proprietary or c) any confidential or proprietary
information which is circulated within MICROSOFT via its internal electronic
mail system or otherwise. I will also not disclose any confidential or
proprietary information to anyone inside MICROSOFT except on a “need-to-know”
basis. If I have any questions as to what comprises such confidential
proprietary information or trade secrets, or to whom, if anyone, inside of
Microsoft, it may be disclosed, I will consult with my manager at MICROSOFT.

3. I will make prompt and full disclosure to MICROSOFT, will hold in trust for
the sole benefit of MICROSOFT, and will assign exclusively to MICROSOFT all my
right, title, and interest in and to any and all inventions, discoveries,
designs, developments, improvements, copyrightable material, and trade secrets
(collectively herein “Inventions”) that I, solely or jointly, may conceive,
develop, or reduce to practice during the period of time I am in the employ of
MICROSOFT. I hereby waive and quitclaim to MICROSOFT any and all claims of any
nature whatsoever that I now or hereafter may have for infringement of any
patent resulting from any patent applications for any inventions so assigned to
MICROSOFT.

My obligation to assign shall not apply to any invention about which I can prove
that

 

  a) It was developed entirely on my own time; and


 

    b)  no equipment, supplies, facility, or trade secret information of MICROSOFT
        was used in its development; and                                          


 

    c)  it does not relate (i) directly to the business of MICROSOFT or (ii) to   
        the actual or demonstrably anticipated research or development of         
        MICROSOFT; and                                                            


 

  d) it does not result from any work performed by me for MICROSOFT.


I will assign to MICROSOFT or its designee all my right, title, and interest in
and to any and all Inventions full title to which may be required to be in the
United States by any contract between MICROSOFT and the United States or any of
its agencies.

4. I have attached hereto a list describing all Inventions belonging to me and
made by me prior to my employment with MICROSOFT that I wish to have excluded
from this Agreement. If no such list is attached, I represent that there are no
such Inventions. If in the course of my employment at MICROSOFT, I use in or
incorporate into a MICROSOFT product, process, or machine, an Invention owned by
me or in which I have an interest, MICROSOFT is hereby granted and shall have an
exclusive royalty-free, irrevocable, worldwide license to make, have made, use,
and sell that invention without restriction as to the extent of my ownership or
interest.

 

                                       7

--------------------------------------------------------------------------------
5. I will execute any proper oath or verify any proper document in connection
with carrying out the terms of this Agreement. If, because of my mental or
physical incapacity or for any other reason whatsoever, MICROSOFT is unable to
secure my signature to apply for or to pursue any application for any United
States or foreign patent or copyright covering inventions assigned to MICROSOFT
as stated above, I hereby irrevocably designate and appoint MICROSOFT and its
duly authorized officers and agents as my agent and attorney in fact, to act for
me and in my behalf and stead to execute and file any such applications and to
do all other lawfully permitted acts to further the prosecution and issuance of
U.S. and foreign patents and copyrights thereon with the same legal force and
effect as if executed by me. I will testify at MICROSOFT’s request and expense
in any interference, litigation, or other legal proceeding that may arise during
or after my employment.

6. I recognize that MICROSOFT has received and will receive confidential or
proprietary information from third parties subject to a duty on MICROSOFT’s part
to maintain the confidentiality of such information and to use it only for
certain limited purposes. During the term of my employment and thereafter I owe
MICROSOFT and such third parties a duty not to disclose such confidential or
proprietary information to anyone except as necessary in carrying out my work
for MICROSOFT and consistent with MICROSOFT’s agreement with such third party. I
will not use such information for the benefit of anyone other than MICROSOFT or
such third party, or in any manner inconsistent with any agreement between
MICROSOFT and such third party of which I am made aware.

7. During my employment at MICROSOFT I will not use improperly or disclose any
confidential or proprietary information or trade secrets of my former or current
employers, principals, partners, co-venturers, clients customers, or suppliers
of the vendors or customers of such persons or entities and I will not bring
onto the premises of MICROSOFT any unpublished document or any property
belonging to any such persons or entities or their vendors or customers unless
such persons or entities have given verbal consent. I will not violate any
non-disclosure or proprietary rights agreement I might have signed in connection
with any such person or entity.

8. I acknowledge that my employment will be of indefinite duration and that
either MICROSOFT or I will be free to terminate this employment relationship at
will and at any time with or without cause. I also acknowledge that any
representations to the contrary are unauthorized and void, unless contained in a
formal written employment contract signed by an officer of Microsoft or its
Director of Training and Personnel Administration. I further acknowledge that
the terms and conditions of this Agreement shall survive termination of my
employment.

9. At the time I leave the employ of MICROSOFT, I will return to MICROSOFT all
papers, drawings, notes, memoranda, manuals, specifications, designs, devices,
documents, diskettes and tapes, and any other material on any media containing
or disclosing any confidential or proprietary technical or business information.
I will also return any keys, pass cards, identification cards or other property
belonging to MICROSOFT.

10. For a period of one year after termination of my employment, I will not
accept employment or engage in activities directly or indirectly competitive
with the business (as defined in paragraph 1 above) or with the actual or
demonstrably anticipated research or development of MICRSOFT as of my
termination date.

11. While employed at MICROSOFT and for a period of one year from the
termination of my employment I will not induce or attempt to influence directly
or indirectly any Employee of MICROSOFT to terminate his employment with
MICROSOFT or to work for me or any other person or entity.

12. I acknowledge that any violation of this Agreement by me will cause
irreparable injury to MICROSOFT, and MICROSOFT shall be entitled to
extraordinary relief in court, including, but not limited to, temporary
restraining orders, preliminary injunctions, and permanent injunctions, without
the necessity of posting bond or security.

13. If court proceedings are required to enforce any provision or to remedy any
breach of this Agreement, the prevailing party shall be entitled to an award of
reasonable and necessary expenses of litigation, including reasonable attorneys’
fees.

14. I agree that this Agreement shall be governed for all purposes by the laws
of the State of Washington as such law applies to contracts to be performed
within Washington by residents of Washington and that venue for any action
arising out of this Agreement shall be properly laid in King County, Washington
or in the Federal

 

                                       8

--------------------------------------------------------------------------------
District Court for the Western District of Washington. If any provision of this
Agreement shall be declared excessively broad, it shall be construed so as to
afford MICROSOFT the maximum protection permissible by law. If any provision of
this Agreement is void or is so declared, such provision shall be severed from
this Agreement, which shall otherwise remain in full force and effect. This
Agreement sets forth the entire Agreement of the parties as to employment at
MICROSOFT and any representations promises, or conditions in connection
therewith not in writing and signed by both parties shall not be binding upon
either party.

HAVING READ AND FULLY UNDERSTOOD THIS AGREEMENT, I have signed my name this 17th
day of July  , 1989

 

                                  /s/ Steven Sinofsky   
                                   Signature            
                                                      
                                  Steven Sinofsky       
                                    Name (Print)        


Inventions listed or attached:     Yes    X  No

 

                              L. Parris                    
                        MICROSOFT CORPORATION WITNESS      


11/1/88

 

                                       9

--------------------------------------------------------------------------------
                                   EXHIBIT B

 

                                     Unvested Shares and Payment Schedule             
          Grant Number    8/31/2013       8/31/2014       8/31/2015       8/31/2016   
          0000000811105        7,695              —               —               —   
          0000001087120       56,681              —               —               —   
          0000001180497       47,368          47,369              —               —   
          0000001299366       49,643          49,643          49,644              —   
          0000001299375       27,580          27,580          27,580          27,580  


 

                                       10

--------------------------------------------------------------------------------
                                   EXHIBIT C

                                 CERTIFICATION

I, Steven Sinofsky, certify that I have complied in all material respects with
the terms of the Retirement Agreement and Full and Final Release of Claims
(attached hereto).

 

                                  /s/ Steven Sinofsky   
                               Steven Sinofsky          
                                                      
                                  June 17, 2013         
                               Date                     


 

                                       11

--------------------------------------------------------------------------------
                                   EXHIBIT D

                              CLIENT/CUSTOMER LIST

Acer

Asus

Dell

HP

HTC

IBM

Intel

Lenovo

LG

Nokia

Qualcomm

Samsung

Sony

Toshiba

 

                                       12




EX-12
3
d527745dex12.htm
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES


 

                                                                      Exhibit 12

               COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES

 

(In millions, except ratios)                                                                                   
------------------------------------------------------------------------------------------------------------- -
                                                                                                 
Year Ended June 30,                         2013            2012           2011           2010           2009  
                                                                                                 
Earnings (a)                                                                                                   
Earnings from continuing operations                                                                           
before income taxes                    $  27,052       $  22,267      $  28,071      $  25,013      $  19,821  
Add: Fixed charges                           489             435            349            207             88  
Add: Cash distributions from equity                                                                           
method investments                            71              74             14             14             85  
Subtract: Income (loss) from equity                                                                           
method investments                           (99 )            27            110             18             81  
------------------------------------------------ --    - ------- -    - ------- -    - ------- -    - ------- -
Total Earnings                         $  27,711       $  22,749      $  28,324      $  25,216      $  19,913  
                                       - ------- --    - ------- -    - ------- -    - ------- -    - ------- -
                                                                                                 
Fixed Charges (b)                                                                                              
Interest expense                       $     394       $     345      $     264      $     146      $      38  
Capitalized debt related expenses             35              35             31              5              0  
Interest component of rental                                                                                  
expense                                       60              55             54             56             50  
------------------------------------------------ --    - ------- -    - ------- -    - ------- -    - ------- -
Total Fixed Charges                    $     489       $     435      $     349      $     207      $      88  
                                       - ------- --    - ------- -    - ------- -    - ------- -    - ------- -
                                                                                                 
Ratio of Earnings to Fixed Charges            57              52             81            122            226  


 

(a) Earnings represent earnings from continuing operations before income taxes   
    and before income (losses) from equity method investments plus: (1) fixed    
    charges; and (2) cash distributions from equity method investments.          


(b) Fixed charges include: (1) interest expense; (2) capitalized debt issuance   
    costs; and (3) the portion of operating rental expense which management      
    believes is representative of the interest component of rental expense.      





EX-21
4
d527745dex21.htm
SUBSIDIARIES OF REGISTRANT


 

                                                                      Exhibit 21

                           SUBSIDIARIES OF REGISTRANT

The following is a list of subsidiaries of the company as of June 30, 2013,
omitting subsidiaries which, considered in the aggregate, would not constitute a
significant subsidiary.

 

            Name                                    Where Incorporated
            ----------------------------------------------------------
            Microsoft Ireland Research              Ireland           
            Microsoft Capital Group, LLC            United States     
            Microsoft Global Finance                Ireland           
            Microsoft Ireland Operations Limited    Ireland           
            Microsoft Licensing, GP                 United States     
            Microsoft Online, Inc.                  United States     
            Microsoft Operations Pte Ltd            Singapore         
            Microsoft Operations Puerto Rico, LLC   Puerto Rico       
            Microsoft Regional Sales Corporation    United States     
            MOL Corporation                         United States     
            Skype Communications S.á r.l.           Luxembourg        





EX-23.1
5
d527745dex231.htm
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


 

                                                                    Exhibit 23.1

            CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in Registration Statement Nos.
333-120511, 333-109185, 333-06298, 333-16665, 333-118764, 333-91755, 333-52852,
333-102240, 333-132100, 333-161516, 333-75243, and 333-185757 on Form S-8 and
Registration Statement Nos. 333-43449, 333-110107, 333-108843, 333-155495, and
333-184717 on Form S-3 of our reports dated July 30, 2013, relating to the
consolidated financial statements of Microsoft Corporation and subsidiaries (the
“Company”), and the effectiveness of the Company’s internal control over
financial reporting, appearing in this Annual Report on Form 10-K of Microsoft
Corporation for the year ended June 30, 2013.

/s/  DELOITTE & TOUCHE LLP

Seattle, Washington

July 30, 2013




EX-31.1
6
d527745dex311.htm
CETIFICATIONS OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302


 

                                                                    Exhibit 31.1

                                 CERTIFICATIONS

I, Steven A. Ballmer, certify that:

1. I have reviewed this annual report on Form 10-K 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/  STEVEN A. BALLMER 
Steven A. Ballmer      
Chief Executive Officer


July 30, 2013




EX-31.2
7
d527745dex312.htm
CETIFICATIONS OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302


 

                                                                    Exhibit 31.2

                                 CERTIFICATIONS

I, Amy E. Hood, certify that:

1. I have reviewed this annual report on Form 10-K 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     


July 30, 2013




EX-32.1
8
d527745dex321.htm
CETIFICATIONS OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906


 

                                                                    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 Annual Report of Microsoft Corporation, a Washington
corporation (the “Company”), on Form 10-K for the year ended June 30, 2013, as
filed with the Securities and Exchange Commission (the “Report”), Steven A.
Ballmer, 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/  STEVEN A. BALLMER 
Steven A. Ballmer      
Chief Executive Officer


July 30, 2013

[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.]




EX-32.2
9
d527745dex322.htm
CETIFICATIONS OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906


 

                                                                    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 Annual Report of Microsoft Corporation, a Washington
corporation (the “Company”), on Form 10-K for the year ended June 30, 2013, 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 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/  AMY E. HOOD            
Amy E. Hood                 
Executive Vice President and
Chief Financial Officer     


July 30, 2013

[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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