Microsoft
Annual Report 2020

Plain-text annual report

Dear shareholders, colleagues, customers, and partners: While the start of a new decade typically brings hope, we quickly saw the world come to a near standstill in 2020, conf ronted by compounding crises: a public health and economic crisis, persistent issues of systemic racial injustice and inequity, and the devastating ef f ects of climate change. It is easy to f all prey to pessimism, or the sense that we individually or as a company can’t make a dif f erence. But helplessness is corrosive to hope, and hope plus work is what is required. Amid this disruption, what’s clear is that we have a once-in-a-generation opportunity to harness digital technology to def ine the world we want to live in. And f or that, I am optimistic. It is in times like these that our ability to stay true to Microsof t’s mission and corporate p urpose is of the utmost importance. As a company, we are steadf ast in our mission to empower every person and every organization on the planet to achieve more. Our mission is enduring. It drives who we are and everything we do, emphasizing our passion to e mpower both people and the lasting institutions they build. And it means we must always use technology to help address the world’s challenges, not create new ones. I’m proud of how our ecosystem of customers and partners has stepped up over the past year to help people and organizations in every country use technology to be resilient and transf orm during the most trying of circumstances. We’ve acted as digital f irst responders to the world’s f irst responders, supporting those on the f ront lines, f rom healt hcare, to education, to public sector, to critical manuf acturing, grocery, and retail. And we’re helping organizations navigate the response, recovery, and reimagine phases of the crisis, equipping them not only to stay open f or business but to innovate. We’ve witnessed years of digital transf ormation in mere months. Amid this rapid change, we delivered strong results: Our commercial cloud surpassed $50 billion in revenue f or the f irst time – up 36 percent year-over-year. All-up, we delivered $143 billion in revenue, $53 billion in operating income, and more than $60 billion in operating cash f low – and returned $35 billion to shareholders. OUR OPPORTUNITY Although this year has taught us that no business is 100 percent resilient, those f ortif ied by digital technology are more resilient and more capable of transf orming when f aced with sweeping changes like those we are experiencing. The way people interact with businesses is f undamentally shif ting, and there is no going back. Digital technology is the most malleable tool ever created, and we believe that businesses that use it to build their own digital capability will recover f a ster and emerge stronger. At Microsof t, we call this dynamic tech intensity: adopting best-in-class digital tools and platf orms for the purpose of building new, proprietary products and services. I’ve been inspired by the ingenuity and creativity of so many people and organizations in every industry around the world applying tech intensity to address big challenges, including those created by COVID -19: • • • • • In healthcare, Dr. Amanda Randles at Duke University is using the power of Azure to conduct hundreds of millions of simulations required to help more patients have access to critical ventilators. In the public sector, the state of Calif ornia built 90 percent of its COVID-19 inf rastructure with GitHub and Azure DevOps, reducing the time it takes to stand up a new website f rom 18 mont hs to just three hours. In telecom, two analysts at T-Mobile used Power Platf orm to build an app that helped the company keep retail associates employed and keep customers, including f irst responders, connected during the critical f irst weeks of the crisis. In retail, Patagonia is using Dynamics 365 to ship inventory directly f rom a store or f rom a warehouse, optimizing to send single shipments to customers, while reducing the load on all locations. In education, the University of Bologna in Italy moved 90 percent of courses f or its 80,000 students online to Microsof t Teams within three days – a f irst in the university’s 900-plus year history. • And, in sports, the NBA is using our technology to reimagine the game experience so f ans can f eel like t hey’re together f rom the saf ety of their homes and players can experience the energy of cheering f ans – virtually – in the arena. 1 We are living in the era of the intelligent cloud and intelligent edge, which is being shaped by rapid advances in distrib uted computing, ambient intelligence, and multisense, multidevice experiences. This means the places we go and the things we interact with will increasingly become digitized, creating new opportunities and new breakthroughs: f rom precision medicine to precision agriculture, f rom personalized e-commerce to personalized education, and f rom connected manuf acturing f loors to connected homes. Our collective opportunity is to channel this intelligent cloud and intelligent edge era into tech intensity f or every o rganization on the planet. Our customer solution areas were built f or this era. They enable people, organizations, and entire industries to not only thrive but reimagine the world. So organizations can empower their employees, f ostering a new culture f or h ybrid work; engage customers intelligently and virtually; transf orm products with new business models; and optimize operations to keep customers and employees saf e and secure. Across our customer solution areas, we are expanding our opportunity to help ev ery organization in every industry build their tech intensity – with a business model that is trusted and aligned with their success. Applications and Infrastructure More than ever, organizations are relying on Azure to stay up and running and support critical workloads, f rom healthcare triage with AI-assisted bots, to digital twins in manuf acturing, to e-commerce in retail. Today, leaders in every industry – including 95 percent of the Fortune 500 – run on Azure. We are building Azure as the world’s computer to support them, with more datacenter regions than any other provider – now 61. Fif ty billion devices will come online by 2030, and Azure is the only cloud that extends to the edge, with consistency across operating models, development models, and inf rastructure stack. Azure Arc enables organizations to deploy Azure services anywhere and extend Azure management to any inf rastructure. Azure Stack Edge brings rapid m achine learning inf erencing closer to where data is generated, including the harshest of conditions, like disaster response. Our acquisitions of Af firmed and Metaswitch, along with new Azure Edge Zones, expand our of f erings f or telecom operators as they mo ve to 5G. And, with Azure Orbital, we’re taking our inf rastructure to space, enabling anyone to access satellite data and capabilities f rom Azure. Data and AI There will be 175 zettabytes of data by 2025, and processing this data in real time will be an imperative f or every organization. At the data layer, Azure is the only cloud with limitless data and analytics capabilities. Azure Synapse brings together big data analytics and data warehousing, enabling data scientists to generate immediate insights f ro m structured and unstructured data. And together with Azure SQL Hyperscale, Cosmos DB, and our other data services, we are able to deliver a cloud-native data estate f or every organization. In AI, we have the most comprehensive portf olio of tools, f ramewo rks, and inf rastructure. Azure Cognitive Services makes it easier to build applications that see, hear, speak, search, understand, and accelerate decision -making. Azure Machine Learning helps organizations build and deploy models f aster, while ensuring they can do so responsibly and saf ely. And, we are pushing the bounds of how AI can generalize learning beyond narrow domains, collaborating with OpenAI on a supercomputing platf orm to train and run AI models of unprecedented scale. Their new GPT-3 model was trained on our Azure AI supercomputer and constitutes a new breakthrough in natural language understanding and generation, promising breakthrough scenarios within our products and those of our customers, when saf ely deployed. Developer Tools Today, the majority of job openings f or developers are outside the tech sector, and developers will increasingly drive and inf luence every business process and f unction. We have the most used and loved developer tools to build any app f or any platf orm. With the world’s most popular code editing tools – Visual Studio and VS Code – developers are more productive than ever. With GitHub, more than 50 million developers across 3 million organizations, including 2 the majority of the Fortune 50, are able to collaborate and build sof tware together. And, with Azure, they have best -in-class services to build cloud-native apps and modernize existing ones. This year, we went f urther to give developers new tools to power remote development, productivit y, and collaboration, wherever they are. Codespaces brings together the best of GitHub, Visual Studio, and Azure to help developers go f rom code to cloud in seconds. VS Live Share enables real-time collaboration between developers, regardless of their location. And with Azure Communications Services, any developer can integrate rich communications APIs into their applications across any device, on any platf orm, using the same reliable and secure inf rastructure that powers Teams. Power Platform 500 million apps will be created by 2023 to drive transf ormation and productivity f or every organization. To accelerate this, we must enable a new category of developers – citizen developers – equipping domain experts with tools that are low-code or no-code to create solutions that solve their unique business needs and help them better collaborate with prof essional developers. With Power Platf orm, anyone can become a citizen developer, able to create an application, build a virtual agent, automate a workf low, and analyze data in hours or days, not weeks or months. Power BI is the clear leader in business intelligence in the cloud. Power Virtual Agents enables anyone to build an intellige nt bot with just a point and click. And Power Automate enables customers to automate manual business processes across both legacy and modern applications. Modern Workplace Microsof t 365 is empowering people and organizations to be productive and secure as they adapt to more f luid ways of working and learning. The PC has been mission-critical across work, school, and lif e to sustain productivity in a remote everything world. More than 1 billion active devices now run Windows 10, and Of f ice 365 usage is higher than ever. New Microsof t Edge – with enterprise-class security – protects individuals’ privacy online and makes it easier to f ind inf ormation at work. And with Surf ace, we are reimagining every layer of the stack – f rom how we inf use AI f rom the silicon up, to device f orm f actors, to the role of operating systems – investing across f orm and f unction to create new device categories. The past six months have served as the largest at-scale experiment we’ve ever seen f or remote work. We’ve been studying this closely to understand the changing nature of productivity and are applying thes e learnings to inf orm how we build our products. We think about the f uture of work through three vectors. First, we are creating a system of collaboration for every organization. Work doesn’t begin and end inside a meeting, and with Teams, we are f ocused o n the entire workf low around a meeting – bef ore, during, and af ter. It’s the only solution with meetings, calls, chat, content collaboration with Of f ice, and business process workf lows, in a secure, integrated user experience. Second, learning in the f low of work will be increasingly important. A new Teams app will help organizations skill, reskill, and upskill employees, surf acing learning content f rom LinkedIn Learning and other content providers. Finally, prioritizing employee well -being is core to an organization’s success. New capabilities like Together mode in Teams help reduce cognitive load, while a new “virtual commute” will provide much - needed structure f or the remote workday. Business Applications Dynamics 365 is helping organizations in every industry digitize their business operations and make every part of their operations remote, f rom manuf acturing, to supply -chain management, to sales and customer service, including new scenarios like contactless shopping. As much as 73 percent of the data in the world is still not being analyzed. And f rom Dynamics 365 Customer Insights f or personalized customer experiences and Dynamics 365 Commerce f or omnichannel retail, Dynamics 365 is the only AI-powered business cloud that gives customers a 360-degree view of their business to unif y data and unlock insights. And the combination of LinkedIn Sales Navigator and Dynamics 365 gives sales prof essionals tools f or more ef f ective remote selling. 3 Amid a rapidly changing jobs market, LinkedIn’s role in creating economic opportunity f or every member of the global workf orce has never been more acute. LinkedIn is where more than 706 million prof essionals around the world go to connect, learn, and plan f or the f uture. People are turning to LinkedIn Learning more than ever to acquire new skills. And we are helping organizations attract, retain, and develop the best talent with our portf olio of Talent Solutions, Talent Insi ghts, and Glint. Security Identity, security, management, and compliance underlie our entire tech stack. Cybercrime will cost businesses, governments, and individuals $1 trillion this year, and the shif t to remote everything has only increased the need f or a “Zer o Trust” architecture that reduces both cost and complexity. We are the only company that of fers integrated, end-to-end capabilities to protect people and organizations. In identity, Azure Active Directory now provides identity and access management to more than 345 million monthly active users across more than 200,000 organizations. In security, Def ender of fers broad coverage, spanning identities, cloud apps, devices, IoT, and more. It complements Azure Sentinel, which analyzes security signals across the entire organization, using AI to detect, investigate, and automatically remediate threats. In device and data management, Microsof t Endpoint Manager monitors and manages an organization’s devices in a unif ied management platf orm. And, in compliance, we provide tools to help organizations govern their data and comply with increasing regulatory requirements. Gaming Gaming is the most expansive category in the entertainment industry. Three billion people around the world look to gaming f or entertainment, community, and achievement, and our ambition is to empower each of them, wherever they pla y. We saw record engagement and monetization this year, led by strength on and of f console, as people everywhere turn to gaming to connect, socialize, and play with their f riends during a time of social distancing. Our Xbox Game Pass service now has more than 15 million subscribers. Quality dif f erentiated content – f rom Flight Simulator to Minecraft – is the engine behind the service’s growth, and our pending acquisition of ZeniMax Media, one of the world’s largest, privately held game developers and publishers, will add iconic f ranchises to the more than 100 high- quality games already available. We’re also transf orming how games are distributed, played, and viewed, bringing cloud gaming to Game Pass, so subscribers can stream games to a phone or tablet and play along with nearly 100 million Xbox Live players. OUR PURPOSE As we pursue our mission, we also recognize our enormous responsibility to ensure the technology we build benef its everyone on the planet, including the planet itself . Our customers see t his urgent need and are looking to us – in partnership with them – to take action. We’re committed to working across the public and private sectors to f oster partnerships and solutions that will have lasting impact and redef ine what “achieve more” means f o r the world. For us, “achieve more” has f our important attributes: Support inclusive economic opportunity First, we must ensure that the economic growth we drive is inclusive. This starts with protecting public health. COVID -19 has underscored that without a healthy society, we cannot sustain a healthy economy. That’s why, through our AI f or Health initiative, we’re empowering those working to tackle some of the toughest challenges in global health, including those on the f ront lines of COVID-19 research. It also requires that we equip everyone with the skills, technology, and opportunity to pursue the in -demand jobs of a changing economy. We’re accelerating ef f orts to close the skills and broadband gaps, ensuring underrepresented and overlooked communities can compete on equal ground. COVID -19 has intensif ied the need f or these ef f orts, forcing tens of millions of people out of work. That’s why we’re bringing together assets f rom across Microsof t, inclusive of LinkedIn and GitHub, to help 25 million job seekers gain digital skills f or in-demand roles. We are also 4 working to expand broadband access to 40 million unserved and underserved people in rural areas globally, and to 3 million people in unserved and rural communities in the US by July 2022. We also prioritize accessibility in our culture, products, and services, ensuring we use technology to design a m ore accessible world f or the 1 billion-plus people around the world with disabilities. As we continue our own accessibility journey, we seek to inspire and enable others to advance theirs, including through our f ive-year investment in AI f or Accessibility. Nonprof its are on the f ront lines of solving some of the world’s most pressing challenges. We make our technology af f ordable and accessible to nonprof it organizations around the world, enabling them to drive greater impact f or the causes and communities they serve. This year, we provided $1.9 billion in donated or discounted products and services to help 243,000 nonprof its better serve their communities. And our employees donated an additional $221 million (including company match) through our employee giving program to the organizations and causes they care about. Protect fundamental rights Second, we unequivocally support the f undamental rights of all people, f rom def ending democracy to addressing systemic racial injustice and inequity around the world . Recent events are shining a bright light on how much work there is still to do. Seeing injustice in the world calls us all to take action. We’re committed to addressing racial injustice and inequity f or the Black and Af rican American community in the United States and f or vulnerable communities globally. This starts with our own culture at Microsof t, extends to how we engage our suppliers and partners to create change, and includes strengthening our communities. Our ef f orts include investing an additional $150 million to advance racial justice and includes work on our own cultural transf ormation, doubling the number of Black-owned suppliers in our ecosystem, doubling the percentage of our transaction volumes through Black -owned f inancial institutions, and accelerating our justice ref orm initiatives. But we can’t stop there. Democracy itself is under attack. That’s why we are helping protect the integrity of our democratic processes and institutions around the world through our Def ending Democracy Program, which works with governments, NGOs, academics, and industry to explore technological solutions to preserve and protect electoral processes an d to def end against disinf ormation. Commit to a sustainable future Third, we must protect our most f inite resource – the planet – by working toward a more sustainable f uture. Over the past year, we’ve set ambitious climate goals and outlined detailed plans to achieve them, including to be carbon negative, zero waste, and water positive by 2030. We are also building a new planetary computing platf orm to help manage Earth’s natural systems. Addressing the climate crisis is good f or the planet and good f or M icrosof t. That’s why we’re innovating and empowering customers, partners, NGOs, and governments around the world with technology to help them set and achieve their own climate goals, including the creation of a $1 billion Climate Innovation Fund to accelerate innovation. Earn trust Finally, we are committed to building trust in technology and its use. Without trust, none of our progress is possible. For Microsof t, trust is built on privacy, security, the responsible use of AI, and transparency. Our approach to privacy and data protection is grounded in our belief that customers own their own data. Our privacy principles include a commitment to be transparent in our privacy practices, to of f er meaningf ul privacy choices, and to responsibly manage the data we store and process. It’s why we were early supporters of the European Union’s General Data Protection Regulation (GDPR) and why we were the f irst major technology company 5 to expand GDPR’s core rights to all our customers around the world. To date, more than 43 million people have visited these tools. Security is a central challenge in the digital age. In an increasingly complex world, technology alone is not enough to combat increasing threats. It also requires partnerships, both with governments and i ndustries. Our Digital Crimes Unit – an international team of technical, legal, and business experts – has coordinated with partners across countries to disrupt threats targeting governments, universities, human rights organizations, individuals, and more. This year, f or example, they took control of domains being used to send COVID -19-themed phishing emails in 62 countries. AI has proved itself to be a powerf ul tool f or tackling the kinds of challenges that this year has highlighted. However, when we build AI, we must do so responsibly, taking a principled approach and asking difficult questions, like not what technology can do, but what should it do? Fairness, reliability and saf ety, privacy and security, inclusiveness, transparency, and accountability are the ethical principles that guide our work and advocacy. Our Of f ice of Responsible AI helps ensure our products adhere to these principles. We’ve released guidelines, sof tware development tools, and other resources to enable our developer community to do the same. Finally, transparency is f oundational to trust, so we provide clear inf ormation on how we run our business and how we work with customers and partners. We provide details on our CSR Reports Hub covering everything f rom law enf orcement access to data, to environmental data, details on our political activities, workf orce demographics, and human rights. OUR CULTURE Ultimately, we will only achieve our mission if we live our culture. It is at the root of every decision we make. We f undamentally believe that we need a culture f ounded in a growth mindset. It starts with a belief that everyone can grow and develop; that potential is nurtured, not predetermined; and that anyone can change their mindset. It’s not by claiming a growth mindset but by knowing that we are imperf ect but can learn and get better that we can close the gap between our espoused culture and the lived experience f or every employee at the company. Our success is dependent on our customers’ success, and we need to obsess about them – listening and then innovating to meet their unmet and unarticulated needs. No customer of ours cares about our organizati onal boundaries, and we need to operate as One Microsof t to deliver the best solutions f or them. Finally, we need to actively seek diversity and embrace inclusion to best serve our customers around the world and create a culture where everyone can do their best work. Diversity and inclusion continues to be a core priority f or every employee at Microsof t as part of our annual perf ormance and development approach. This past year, we expanded our global allyship program, adapting learning experiences f or the work f rom home conditions of COVID-19. As we ref lect on our opportunity to address racial injustice, we announced our aspiration to increase representation and strengthen our culture of inclusion, including a commitment to double the number of Black and Af rican American and Hispanic and Latinx people managers, senior individual contributors, and senior leaders in the US by 2025. If we commit to being customer obsessed, operating as One Microsof t, and becoming more diverse and inclusive, I believe there is no limit to what we can achieve. The world is at an inf lection point, and digital technology will be key to def ining what comes next. Over the next decade, technology spending as a percentage of gross domestic product is projected to double. And, we are we ll positioned to not only participate in that growth but drive it by expanding our impact and building the key technologies that empower every person and every organization on the planet to achieve more. Satya Nadella Chief Executive Of f icer October 13, 2020 6 (In millions, except per share amounts) FINANCIAL HIGHLIGHTS Year Ended June 30, Revenue Gross margin Operating income Net income Diluted earnings per share Cash dividends declared per common share Cash, cash equivalents, and short-term investments Total assets Long-term obligations Stockholders’ equity 2020 $ 143,015 96,937 52,959 44,281 5.76 2.04 136,527 301,311 110,697 118,304 2019 (a) $ 125,843 82,933 42,959 39,240 (b) 5.06 (b) 1.84 2018 $ 110,360 72,007 35,058 16,571 (c) 2.13 (c) 1.68 133,819 286,556 114,806 102,330 133,768 258,848 117,642 82,718 2017 (d)(e) 2016 (d) $ 96,571 62,310 29,025 (f) 25,489 (f) 3.25 (f) 1.56 132,981 250,312 106,856 87,711 $ 91,154 58,374 26,078 (g) 20,539 (g) 2.56 (g) 1.44 113,240 202,897 66,705 83,090 (a) GitHub has been included in our consolidated results of operations starting on the October 25, 2018 acquisition date. Includes a $2.6 billion net income tax benefit related to intangible property transfers and a $157 million net charge (b) related to the enactment of the Tax Cuts and Jobs Act (“TCJA”), which t ogether increased net income and diluted earnings per share (“EPS”) by $2.4 billion and $0.31, respectively. Refer to Note 12 – Income Taxes of the Notes to Financial Statements. Includes a $13.7 billion net charge related to the enactment of the TCJA, which decreased net income and diluted EPS by $13.7 billion and $1.75, respectively. Refer to Note 12 – Income Taxes of the Notes to Financial Statements. (d) Reflects the impact of the adoption of new accounting standards in fiscal year 2018 related to revenue recognition and (c) leases. (e) LinkedIn has been included in our consolidated results of operations starting on the December 8, 2016 acquisition (f ) (g) date. Includes $306 million of employee severance expenses primarily related to our sales and marketing restructuring plan, income, net income, and diluted EPS by $306 million, $243 million, and $0.04, which decreased operating respectively. Includes $630 million of asset impairment charges related to our Phone business and $480 million of restructuring charges associated with our Phone business restructuring plans, which together decreased operating income, net income, and diluted EPS by $1.1 billion, $895 million, and $0.11, respectively. ISSUER PURCHASES OF EQUITY SECURITIES, DIVIDENDS, AND STOC K PERFORMANCE SHARE REPURCHASES AND DIVIDENDS Share Repurchases On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. This share repurchase program commenced in December 2016 and was completed in February 2020. On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. This share repurchase program commenced in February 2020, f ollowing completion of the program approved on September 20, 2016, has no expiration date, and may be terminated at any time. As of June 30, 2020, $31.7 billion remained of this $40.0 billion share repurchase program. 7 We repurchased the f ollowing shares of common stock under the share repurchase programs: (In millions) Year Ended June 30, First Quarter Second Quarter Third Quarter Fourth Quarter Total Shares Amount Shares Amount Shares 2020 29 $ 4,000 4,600 32 6,000 37 28 5,088 126 $ 19,688 2019 24 $ 2,600 6,100 57 3,899 36 33 4,200 150 $ 16,799 Amount 2018 22 $ 1,600 1,800 22 3,100 34 21 2,100 99 $ 8,600 Shares repurchased during the f ourth quarter of f iscal year 2020 were under the share repurchase program approved on September 18, 2019. Shares repurchased during the third quarter of f iscal year 2020 were under the share repurchase programs approved on both September 20, 2016 and September 18, 2019. All other shares repurchased were under the share repurchase program approved on September 20, 2016. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stoc k awards of $3.3 billion, $2.7 billion, and $2.1 billion f or f iscal years 2020, 2019, and 2018, respectively. All share repurchases were made using cash resources. Dividends Our Board of Directors declared the f ollowing dividends: Declaration Date Fiscal Year 2020 September 18, 2019 December 4, 2019 March 9, 2020 June 17, 2020 Total Fiscal Year 2019 September 18, 2018 November 28, 2018 March 11, 2019 June 12, 2019 Total Record Date Payment Date November 21, 2019 December 12, 2019 March 12, 2020 February 20, 2020 June 11, 2020 May 21, 2020 August 20, 2020 September 10, 2020 Dividend Per Share Amount (In millions) $ 0.51 $ 3,886 3,876 3,865 3,861 $ 2.04 $ 15,488 0.51 0.51 0.51 November 15, 2018 December 13, 2018 March 14, 2019 February 21, 2019 June 13, 2019 May 16, 2019 August 15, 2019 September 12, 2019 $ 0.46 $ 3,544 3,526 3,521 3,510 0.46 0.46 0.46 $ 1.84 $ 14,101 The dividend declared on June 17, 2020 was included in other current liabilities as of June 30, 2020. 8 STOCK PERFORMANCE COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* Among Microsof t Corporation, the S&P 500 Index and the NASDAQ Computer Index Microsoft Corporation S&P 500 NASDAQ Computer 6/15 100.00 100.00 100.00 6/16 119.12 103.99 102.87 6/17 164.45 122.60 142.49 6/18 239.83 140.23 187.03 6/19 331.13 154.83 203.97 6/20 509.27 166.45 296.29 * $100 invested on 6/30/15 in stock or index, including reinvestment of dividends. 9 Note About Forward-Looking Statements This report includes estimates, projections, statements relating to our business plans, objectives, and expected operating results that are “f orward-looking statements” within the meaning of the Private Securities Litigation Ref orm Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. Forward -looking statements may appear throughout this report, including the f ollowing sections: “Business”, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. These f orward -looking statements generally are identif ied by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “f uture,” “opportunity,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward -looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that may cause actual results to dif f er materially. We describe risks and uncertainties that could cause actual results and events to dif f er materially in “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Quantitative and Qualitative Disclosures about Market Risk” in our f iscal year 2020 Form 10-K. Readers are cautioned not to place undue reliance on f orward-looking statements, which speak only as of the date they are made. We undertake no obligation to update or revise publicly any f orward -looking statements, whether because of new inf ormation, f uture events, or otherwise. BUSINESS GENERAL Embracing Our Future Microsof t is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platf orms and tools help drive small business productivity, large business competitiveness, and public -sector ef f iciency. They also support new startups, improve educational and health outcomes, and empower human ingenuity. As the world responds to the outbreak of a novel strain of the coronavirus (“COVID -19”), we are working to do our part by ensuring the saf ety of our employees, striving to protect the health and well-being of the communities in which we operate, and providing technology and resources to our customers to help them do their best work while remote. We continue to transf orm our business to lead in the new era of the intelligent cloud and intelligent edge. We bring technology and products together into experiences and solutions that unlock value f or our customers. Our unique role as a platf orm and tools provider allows us to connect the dots, bring together an ecosystem of partners, and enable organizations of all sizes to build the digital capability required to address these challenges. In this next phase of innovation, computing is more powerf ul and ubiquitous from the cloud to the edge. Artificial intelligence (“AI”) capabilities are rapidly advancing, f ueled by data and knowledge of the world. Physical and virtual worlds are coming together with the Internet of Things (“IoT”) and mixed reality to create richer experiences that understand the context surrounding people, the things they use, the places they go, and t heir activities and relationships. A person’s experience with technology spans a multitude of devices and has become increasingly more natural and multi -sensory with voice, ink, and gaze interactions. What We Offer Founded in 1975, we develop and support sof tware, services, devices, and solutions that deliver new value f or customers and help people and businesses realize their f ull potential. We of f er an array of services, including cloud -based solutions that provide customers with sof tware, services, platf orms, and content, and we provide solution support and consulting services. We also deliver relevant online advertising to a global audience. 10 Our products include operating systems; cross -device productivity applications; server applications; business solution applications; desktop and server management tools; sof tware development tools; and video games. We also design, manuf acture, and sell devices, including PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. The Ambitions That Drive Us To achieve our vision, our research and development ef f orts f ocus on three interconnected ambitions: • Reinvent productivity and business processes. • Build the intelligent cloud and intelligent edge platf orm. • Create more personal computing. Reinvent Productivity and Business Processes At Microsof t, we’re providing technology and resources to help our customers navigate a remote environment. We’re s eeing our f amily of products play key roles in the ways the world is continuing to work, learn, and connect. Our growth depends on securely delivering continuous innovation and advancing our leading productivity and collaboration tools and services, including Of f ice, Dynamics, and LinkedIn. Microsof t 365 brings together Of f ice 365, Windows 10, and Enterprise Mobility + Security to help organizations empower their employees with AI-backed tools that unlock creativity, increase teamwork, and f uel innovation, all the while enabling compliance coverage and data protection. Microsof t Teams is enabling rapid digital transf ormation by giving people a single tool to chat, call, meet, and collaborate. Microsoft Relationship Sales solution brings together LinkedIn Sales Navigator and Dynamics to transf orm business to business sales through social selling. Dynamics 365 f or Talent with LinkedIn Recruiter and Learning gives human resource prof essionals a complete solution to compete f or talent. Microsof t Power Platf orm empowers employees to build custom applications, automate workf low, and analyze data no matter their technical expertise. These scenarios represent a move to unlock creativity and discover new habits, while simplif ying security and management. Organizations of all sizes have digitized business-critical f unctions, redef ining what they can expect f rom their business applications. This creates an opportunity to reach new customers and increase usage and engagement with existing customers. Build the Intelligent Cloud and Intelligent Edge Platform In the new remote world, companies have accelerated their own digital transf ormation to empower their employees, optimize their operations, engage customers, and in some cases, change the very core of their products a nd services. Partnering with organizations on their digital transf ormation during this period is one of our largest opportunities and we are uniquely positioned to become the strategic digital transf ormation platf orm and partner of choice; their success is our success. Our strategy requires continued investment in datacenters and other hybrid and edge inf rastructure to support our services. Azure is a trusted cloud with comprehensive compliance coverage and AI-based security built in. Our cloud business benef its f rom three economies of scale: datacenters that deploy computational resources at signif icantly lower cost per unit than smaller ones; datacenters that coordinate and aggregate diverse customer, geographic, and application demand patterns, improving the utilization of computing, storage, and network resources; and multi -tenancy locations that lower application maintenance labor costs. As one of the two largest providers of cloud computing at scale, we believe we work f rom a position of strength. Be ing a global-scale cloud, Azure uniquely of f ers hybrid consistency, developer productivity, AI capabilities, and 11 trusted security and compliance. We see more emerging use cases and needs f or compute and security at the edge and are accelerating our innovation across the spectrum of intelligent edge devices, f rom IoT sensors to gateway devices and edge hardware to build, manage, and secure edge workloads. With Azure Stack, organizations can extend Azure into their own datacenters to create a consistent stack across the public cloud and the intelligent edge. Our hybrid inf rastructure consistency spans identity, data, compute, management, and security, helping to support the real -world needs and evolving regulatory requirements of commercial customers and enterprises. We are accelerating our development of mixed reality solutions with new Azure services and devices. The opportunity to merge the physical and digital worlds, when combined with the power of Azure cloud services, unlocks the potential f or entirely new workloads which we believe will shape the next era of computing. The ability to convert data into AI drives our competitive advantage. Azure SQL Database makes it possible f or customers to take SQL Server f rom their on-premises datacenter to a f ully managed instance in the cloud to utilize built-in AI. We are accelerating adoption of AI innovations f rom research to products. Our innovation helps every developer be an AI developer, with approachable new tools f rom Azure Machine Learning Studio f or creating simple machine learning models, to the powerf ul Azure Machine Learning Workbench f or the most advanced AI modeling and data science. Create More Personal Computing We strive to make computing more personal by putting users at the core of the experience, enabling them to interact with technology in more intuitive, engaging, and dynamic ways. In support of this, we are bringing Of f ice, Windows, and devices together f or an enhanced and more cohesive customer experience. Windows 10 serves the enterprise as the most secure and productive operating system. It empowers people with AI-f irst interf aces ranging f rom voice-activated commands through Cortana, inking, immersive 3D content storytelling, and mixed reality experiences. Our ambition f or Windows 10 monetization opportunities includes gaming, services, subscriptions, and search advertising. Windows also plays a critical role in f ueling our cloud business and Microsof t 365 strategy, and it power s the growing range of devices on the “intelligent edge.” We are committed to designing and marketing f irst-party devices to help drive innovation, create new device categories, and stimulate demand in the Windows ecosystem. We recently added several new products and accessories into the Surf ace f amily, including Surf ace Book 3 and Surf ace Go 2. These new Surf ace products join Surf ace Pro 7, Surf ace Laptop 3, and Surf ace Pro X. To expand usage and deepen engagement, we continue to invest in content, community, and cloud services as we pursue the expansive opportunity in the gaming industry. We are broadening our approach to how we think about gaming end -to- end, f rom the way games are created and distributed to how they are played and viewed across PC, console, and mobile. We have a strong position with our large and growing highly engaged community of gamers. Xbox Game Pass, with over 10 million members f rom 41 countries, is a community with access to a curated library of over 100 f irst - and third-party console and PC titles. Project xCloud is Microsof t’s game streaming technology that is complementary to our console hardware and will give f ans the ultimate choice to play the games they want, with the people they want, on the devices they want. Our Future Opportunity In a time of great disruption and uncertainty, customers are looking to us to accelerate their own digital transf ormations as sof tware and cloud computing play a huge role across every industry and around the world. We continue to develop complete, intelligent solutions f or our customers that empower p eople to stay productive and collaborate, while saf eguarding businesses and simplif ying IT management. Our goal is to lead the industry in several distinct areas of technology over the long-term, which we expect will translate to sustained growth. We are investing signif icant resources in: • Transf orming the workplace to deliver new modern, modular business applications to improve how people communicate, collaborate, learn, work, play, and interact with one another. 12 • Building and running cloud-based services in ways that unleash new experiences and opportunities f or businesses and individuals. • Applying AI to drive insights and act on our customer’s behalf by understanding and interpreting their needs using natural methods of communication. • Using Windows to f uel our cloud business and Microsof t 365 strategy, and to develop new categories of devices – both our own and third-party – on the intelligent edge. Inventing new gaming experiences that bring people together around their shared love f or ga mes on any devices and pushing the boundaries of innovation with console and PC gaming by creating the next wave of entertainment. • Our f uture growth depends on our ability to transcend current product category def initions, business models, and sales motions. We have the opportunity to redef ine what customers and partners can expect and are working to deliver new solutions that ref lect the best of Microsoft. COVID-19 In March 2020, the World Health Organization declared the outbreak of COVID -19 to be a pandemic. The COVID-19 pandemic is having widespread, rapidly evolving, and unpredictable impacts on global society, economies, f inancial markets, and business practices. Federal and state governments have implemented measures in an ef f ort to contain the virus, including social distancing, travel restrictions, border closures, limitations on public gatherings, work f rom home, supply chain logistical changes, and closure of non-essential businesses. To protect the health and well-being of our employees, suppliers, and customers, we have made substantial modif ications to employee travel policies, implemented of f ice closures as employees are advised to work f rom home, and cancelled or shif ted our conf erences and other marketing events to virtual-only through f iscal year 2021. The COVID-19 pandemic has impacted and may continue to impact our business operations, including our employees, customers, partners, and communities, and there is substantial uncertainty in the nature and degree of its continued ef f ects over time. Ref er to Management’s Discussion and Analysis of Financial Condition and Results of Operations f or f urther discussion regarding the impact of COVID -19 on our f iscal year 2020 f inancial results. The extent to which the COVID-19 pandemic impacts our business going f orward will depend on numerous evolving f actors we cannot reliably predict, including the duration and scope of the pandemic; governmental, business, and individuals’ actions in response to the pandemic; and the impact on economic activity i ncluding the possibility of recession or f inancial market instability. These f actors may adversely impact consumer, business, and government spending on technology as well as customers’ ability to pay f or our products and services on an ongoing basis. This uncertainty also af f ects management’s accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions, including investments, receivables, and f orward -looking guidance. Ref er to Risk Factors in our f iscal year 2020 Form 10-K f or a discussion of these f actors and other risks. Commitment to Sustainability We work to ensure that technology is inclusive, trusted, and increases sustainability. We’re empowering our customers a nd partners with new technology to help them drive ef f iciencies, transf orm their businesses, and create their own solutions for sustainability. In January 2020, we announced a bold new environmental sustainability strategy f ocused on carbon, water, waste, and ecosystems. As part of our commitment, we are investing $1 billion over the next f our years in new technologies and innovative climate solutions. We set an ambitious goal to reduce and ultimately remove Microsof t’s carbon footprint. By 2030 Microsof t will be carbon negative, and by 2050 Microsof t will remove f rom the environment all the carbon the company has emitted directly or by electrical consumption since it was f ounded in 1975. We also launched a new initiative to use Microsof t technology to help our suppliers and customers around the world reduce their own carbon f ootprint. The investments we make in sustainability carry through to our products, services, and devices. We design our devices, f rom Surf ace to Xbox, to minimize their impact on the environment. Our cloud and AI services help 13 businesses cut energy consumption, reduce physical f ootprints, and design sustainable products. We also pledged a $50 million investment in AI f or Earth to accelerate innovation by putting AI in the hands of those working to directly address sustainability challenges. Lastly, this work is supported by using our voice to support policies we think can advance sustainability ef f orts. Addressing Racial Injustice Our f uture opportunity depends on reaching and empowering all communities, and we are committed to taking action to help address racial injustice and inequity. With signif icant input f rom employees and leaders who are members of the Black and Af rican American community, our senior leadership team and board of directors has developed a set of actions to help improve the lived experience at Microsof t and drive change in the communities in which we live and work. These ef f orts include increasing our representation and culture of inclusion by doubling the number of Black and Af rican American people managers, senior individual contributors, and senior leaders in the United States by 2025; engaging our ecosystem by using our balance sheet and engagement with suppliers and partners to extend the vision f or societal change; and strengthening our communities by using the power of data, technology, and partnership to help improve the lives of Black and Af rican American citizens across the United States. Investing in Digital Skills With a continued f ocus on digital transf ormation, Microsof t is making ef f orts to help ensure that no one is lef t behind, particularly as economies start to recover f rom the COVID -19 pandemic. We are expanding access to the digital skills that have become increasingly vital to many of the world’s jobs, and especially to individuals hardes t hit by recent job losses, including those with lower incomes, women, and underrepresented minorities. Our skills initiative brings together learning resources, certif ication opportunities, and job -seeker tools f rom LinkedIn, GitHub, and Microsof t Learn, and is built on data insights drawn f rom LinkedIn’s Economic Graph. This is combined with $20 million we are investing in key non-profit partnerships through Microsof t Philanthropies. OPERATING SEGMENTS We operate our business and report our f inancial perf ormance using three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Our segments provide management with a comprehensive f inancial 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 f ramework f or timely and rational allocation of resources within businesses. Additional inf ormation on our operating segments and geographic and produc t inf ormation is contained in Note 19 – Segment Inf ormation and Geographic Data of the Notes to Financial Statements. Our reportable segments are described below. Productivity and Business Processes Our Productivity and Business Processes segment consis ts of products and services in our portf olio of productivity, communication, and inf ormation services, spanning a variety of devices and platf orms. This segment primarily comprises: • Of f ice Commercial, including Of f ice 365 subscriptions, the Of f ice porti on of Microsof t 365 Commercial subscriptions, and Of f ice licensed on-premises, comprising Of f ice, Exchange, SharePoint, Microsof t Teams, Of f ice 365 Security and Compliance, and Skype f or Business, and related Client Access Licenses (“CALs”). • Of f ice Consumer, including Microsof t 365 Consumer (f ormerly Of f ice 365 Consumer) subscriptions and Of f ice licensed on-premises, and Of f ice Consumer Services, including Skype, Outlook.com, and OneDrive. 14 • LinkedIn, including Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions. • Dynamics business solutions, including Dynamics 365, a set of cloud -based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises. Office Commercial Of f ice Commercial is designed to increase personal, team, and organizational productivity through a range of products and services. Growth depends on our ability to reach new users in new markets such as f irst -line workers, small and medium businesses, and growth markets, as well as add value to our core product and service of f erings to span productivity categories such as communication, collaboration, analytics, security, and compliance. Of fice Commercial revenue is mainly af f ected by a combination of continued installed base growth and average revenue per user expansion, as well as the continued shif t f rom Of f ice licensed on-premises to Of f ice 365. CALs provide certain Of f ice Commercial products and services with access rights to our server products and CA L revenue is reported with the associated Of f ice products and services. Office Consumer Of f ice Consumer is designed to increase personal productivity through a range of products and services. Growth depends on our ability to reach new users, add value to our core product set, and continue to expand our product and service of f erings into new markets. Of f ice Consumer revenue is mainly af f ected by the percentage of customers that buy Of f ice with their new devices and the continued shif t f rom Of f ice licensed on-premises to Microsof t 365 Consumer subscriptions. Office Consumer Services revenue is mainly af f ected by the demand f or communication and storage through Skype, Outlook.com, and OneDrive, which is largely driven by subscriptions, advertising, and the sale of minutes. LinkedIn LinkedIn connects the world’s prof essionals to make them more productive and successf ul and transf orms the way companies hire, market, sell, and learn. Our vision is to create economic opportunity f or every member of the global workf orce through the ongoing development of the world’s f irst Economic Graph, a digital representation of the global economy. In addition to LinkedIn’s f ree services, LinkedIn of f ers monetized solutions: Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions. Talent Solutions provide insights f or workf orce planning and tools to hire, nurture, and develop talent. Learning Solutions, including Glint, help businesses close critical skills ga ps in times where companies are having to do more with existing talent. Marketing Solutions help companies grow relationships between businesses. Sales Solutions help companies strengthen customer relationships, empower teams with digital selling tools, and acquire new opportunities. Finally, Premium Subscriptions enables prof essionals to manage their prof essional identity, grow their network, and connect with talent through additional services like premium search. LinkedIn has over 700 million members and has of f ices around the g lobe. Growth will depend on our ability to increase the number of LinkedIn members and our ability to continue of f ering services that provide value f or our members and increase their engagement. LinkedIn revenue is mainly af f ected by demand f rom enterprises and prof essional organizations f or subscriptions to Talent Solutions, Learning Solutions, Sales Solutions, and Premium Subscriptions offerings, as well as member engagement and the quality of the sponsored content delivered to those members to drive Mark eting Solutions. Dynamics Dynamics provides cloud-based and on-premises business solutions f or f inancial management, enterprise resource planning (“ERP”), customer relationship management (“CRM”), supply chain management, and other application development platf orms f or small and medium businesses, large organizations, and divisions of global enterprises. Dynamics revenue is driven by the number of users licensed, expansion of average revenue per user, and the continued shif t to Dynamics 365, a unif ied set of cloud-based intelligent business applications. 15 Competition Competitors to Of f ice include sof tware and global application vendors, such as Apple, Cisco Systems, Facebook, Google, IBM, Okta, Proof point, Slack, Symantec, Zoom, and numerous web -based and mobile application competitors as well as local application developers. Apple distributes versions of its pre-installed application software, such as email and calendar products, through its PCs, tablets, and phones. Cisco Systems is using its position in enterprise communications equipment to grow its unif ied communications business. Google provides a hosted messaging and productivity suite. Slack provides teamwork and collaboration sof tware. Zoom of f ers videoconferencing and cloud phone solutions. Sky pe f or Business and Skype also compete with a variety of instant messaging, voice, and video communication providers, ranging f rom start -ups to established enterprises. Okta, Proof point, and Symantec provide security solutions across email security, inf orm ation protection, identity, and governance. Web -based of f erings competing with individual applications have also positioned themselves as alternatives to our products and services. We compete by providing powerf ul, f lexible, secure, integrated industry-specif ic, and easy-to-use productivity and collaboration tools and services that create comprehensive solutions and work well with technologies our customers already have both on-premises or in the cloud. LinkedIn f aces competition f rom online prof essional networks, recruiting companies, talent management companies, and larger companies that are f ocusing on talent management and human resource services; job boards; traditional recruiting f irms; and companies that provide learning and development products and services. Marketing Solutions competes with online and of f line outlets that generate revenue f rom advertisers and marketers, and Sales Solutions competes with online and of f line outlets f or companies with lead generation and customer intelligence and insig hts. Dynamics competes with vendors such as Oracle, Salesf orce.com, and SAP to provide cloud -based and on-premises business solutions f or small, medium, and large organizations. Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: • Server products and cloud services, including Azure; SQL Server, Windows Server, Visual Studio, System Center, and related CALs; and GitHub. • Enterprise Services, including Premier Support Services and Microsof t Consulting Services. Server Products and Cloud Services Azure is a comprehensive set of cloud services that of fer developers, IT prof essionals, and enterprises f reedom to build, deploy, and manage applications on any platf orm or device. Customers can use Azure through our global network of datacenters f or computing, networking, storage, mobile and web appli cation services, AI, IoT, cognitive services, and machine learning. Azure enables customers to devote more resources to development and use of applications that benefit their organizations, rather than managing on-premises hardware and sof tware. Azure revenue is mainly af f ected by inf rastructure-as-a-service and platf orm-as-a-service consumption-based services, and per user-based services such as Enterprise Mobility + Security. Our server products are designed to make IT prof essionals, developers, and thei r systems more productive and ef f icient. Server sof tware is integrated server inf rastructure and middleware designed to support sof tware applications built on the Windows Server operating system. This includes the server platf orm, database, business intell igence, storage, management and operations, virtualization, service-oriented architecture platf orm, security, and identity sof tware. We also license standalone and sof tware development lif ecycle tools f or sof tware architects, developers, testers, and proje ct managers. GitHub provides a collaboration platf orm and code hosting service f or developers. Server products revenue is mainly af f ected by purchases through volume licensing programs, licenses sold to original equipment manuf acturers (“OEM”), and retail packaged products. CALs provide access rights to certain server products, including SQL Server and Windows Server, and revenue is reported along with the associated server product. 16 Enterprise Services Enterprise Services, including Premier Support Services and Microsof t Consulting Services, assist customers in developing, deploying, and managing Microsof t server and desktop solutions and provide training and certif ication to developers and IT prof essionals on various Microsof t products. Competition Azure f aces diverse competition f rom companies such as Amazon, Google, IBM, Oracle, VMware, and open source of f erings. Our Enterprise Mobility + Security of ferings also compete with products f rom a range of competitors including identity vendors, security solution vendors, and numerous other security point solution vendors. Azure’s competitive advantage includes enabling a hybrid cloud, allowing deployment of existing datacenters with our public cloud into a single, cohesive inf rastructure, and the ability to run at a scale that meets the needs of businesses of all sizes and complexities. We believe our cloud’s global scale, coupled with our broad portf olio of identity and security solutions, allows us to ef f ect ively solve complex cybersecurity challenges f or our customers and dif f erentiates us f rom the competition. Our server products f ace competition f rom a wide variety of server operating systems and applications of fered by companies with a range of market approaches. Vertically integrated computer manuf ac turers such as Hewlett-Packard, IBM, and Oracle of f er their own versions of the Unix operating system preinstalled on server hardware. Nearly all computer manuf acturers of f er server hardware f or the Linux operating system and many contribute to Linux operating system development. The competitive position of Linux has also benef ited f rom the large number of compatible applications now produced by many commercial and non-commercial sof tware developers. A number of companies, such as Red Hat, supply versions o f Linux. We compete to provide enterprise-wide computing solutions and point solutions with numerous commercial sof tware vendors that of f er solutions and middleware technology platf orms, software applications f or connectivity (both Internet and intranet), security, hosting, database, and e-business servers. IBM and Oracle lead a group of companies f ocused on the Java Platf orm Enterprise Edition that competes with our enterprise-wide computing solutions. Commercial competitors for our server applications f or PC-based distributed client-server environments include CA Technologies, IBM, and Oracle. Our web application platf orm sof tware competes with open source sof tware such as Apache, Linux, MySQL, and PHP. In middleware, we compete against Java vendors. Our database, business intelligence, and data warehousing solutions of f erings compete with products f rom IBM, Oracle, SAP, and other companies. Our system management solutions compete with server management and server virtualization platf orm providers, such as BMC, CA Technologies, Hewlett-Packard, IBM, and VMware. Our products f or sof tware developers compete against of f erings f rom Adobe, IBM, Oracle, and other companies, and also against open -source projects, including Eclipse (sponsored by CA Technologies, IBM, Oracle, and SAP), PHP, and Ruby on Rails. We believe our server products provide customers with advantages in perf ormance, total costs of ownership, and productivity by delivering superior applications, development tools, compatibility with a broad ba se of hardware and sof tware applications, security, and manageability. Our Enterprise Services business competes with a wide range of companies that provide strategy and business planning, application development, and inf rastructure services, including multinational consulting f irms and small niche businesses f ocused on specif ic technologies. More Personal Computing Our More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: • Windows, including Windows OEM licensing (“Windows OEM”) and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating 17 system, Windows cloud services, and other Windows commercial of f erings; patent licensing; Windows IoT; and MSN advertising. • Devices, including Surf ace and PC accessories. • Gaming, including Xbox hardware and Xbox content and services, comprising Xbox Live (transactions, subscriptions, cloud services, and advertising), video games, and third -party video game royalties. • Search. Windows The Windows operating system is designed to deliver a more personal computing experience f or users by enabling consistency of experience, applications, and inf ormation across their devices. Windows OEM revenue is impacted signif icantly by the number of Windows operating system licenses purchased by OEMs, which they pre-install on the devices they sell. In addition to computing device market volume, Windows OEM revenue is impacted by: • The mix of computing devices based on f orm f actor and screen size. • Dif f erences in device market demand between developed markets and growth markets. • Attachment of Windows to devices shipped. • Customer mix between consumer, small and medium businesses, and large enterprises. • Changes in inventory levels in the OEM channel. • Pricing changes and promotions, pricing variation that occurs when the mix of devices manuf actured shif ts f rom local and regional system builders to large multinational OEMs, and dif f erent pricing of Windows versions licensed. • Constraints in the supply chain of device components. • Piracy. Windows Commercial revenue, which includes volume licensing of the Windows operating system and Windows cloud services such as Microsof t Def ender Advanced Threat Protection, is af f ected mainly by the demand f rom commercial customers f or volume licensing and Sof tware Assurance (“SA”), as well as advanced security of f erings. Windows Commercial revenue of ten ref lects the number of inf ormation workers in a licensed enterprise and is relatively inde pendent of the number of PCs sold in a given year. Patent licensing includes our programs to license patents we own f or use across a broad array of technology areas, including mobile devices and cloud of ferings. Windows IoT extends the power of Windows and the cloud to intelligent systems by delivering specialized operating systems, tools, and services f or use in embedded devices. MSN advertising includes both native and display ads. Devices We design, manuf acture, and sell devices, including Surf ace and PC accessories. Our devices are designed to enable people and organizations to connect to the people and content that matter most using Windows and integrated Microsoft products and services. Surf ace is designed to help organizations, students, and consumers be more productive. Growth in Devices is dependent on total PC shipments, the ability to attract new customers, our product roadmap, and expanding into new categories. Gaming Our gaming platf orm is designed to provide a variety of entertainment through a unique combination of content, community, and cloud. Our exclusive game content is created through Xbox Game Studios, a collection of f irst -party 18 studios creating iconic and dif f erentiated gaming experiences. We continue to invest in new gaming studios and content to expand our IP roadmap and leverage new content creators. These unique gaming experiences are the cornerstone of Xbox Game Pass, a subscription service and gaming community with access to a curated library of over 100 f irst- and third-party console and PC titles. The gamer remains at the heart of the Xbox ecosystem. We continue to open new opportunities f or gamers to engage both on- and of f -console with both the launch of Project xCloud, our game streaming service, and continued investment in gaming hardware. Project xCloud utilizes Microsof t’s Azure cloud technology to allow direct and on-demand streaming of games to PCs, consoles, and mobile devices, enabling gamers to take t heir f avorites games with them and play on the device most convenient to them. Project xCloud will provide players with more choice over how and where they play. Xbox Live enables people to connect and share online gaming experiences and is accessible on Xbox consoles, Windows- enabled devices, and other devices. Xbox Live is designed to benef it users by providing access to a network of certif ied applications and services and to benef it our developer and partner ecosystems by providing access to a large cus tomer base. Xbox revenue is mainly af f ected by subscriptions and sales of f irst - and third-party content, as well as advertising. Growth of our Gaming business is determined by the overall active user base through Xbox enabled content, availability of games, providing exclusive game content that gamers seek, the computational power and reliability of the devices used to access our content and services, and the ability to create new experiences through f irst -party content creators. Search Our Search business, including Bing and Microsof t Advertising, is designed to deliver relevant online advertising to a global audience. We have several partnerships with other companies, including Verizon Media Group, through which we provide and monetize search queries. Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser of f erings. Competition Windows f aces competition f rom various sof tware products and f rom alternative platf orms and devices, mainly f rom Apple and Google. We believe Windows competes ef f ectively by giving customers choice, value, f lexibility, security, an easy -to- use interf ace, and compatibility with a broad range of hardware and sof tware applications, including those that enable productivity. Devices f ace competition f rom various computer, tablet, and hardware manuf acturers who of fer a unique combination of high-quality industrial design and innovative technologies across various price points. These manuf acturers, many of which are also current or potential partners and customers, include Apple and our Windows OEMs. Xbox Live and our cloud gaming services f ace competition f rom various online gaming ecosystems and game streaming services, including those operated by Amazon, Apple, Fac ebook, Google, and Tencent. We also compete with other providers of entertainment services such as Netf lix and Hulu. Our gaming platf orm competes with console platf orms from Nintendo and Sony, both of which have a large, established base of customers. We b elieve our gaming platf orm is ef f ectively positioned against, and uniquely dif f erentiated f rom, competitive products and services based on signif icant innovation in hardware architecture, user interf ace, developer tools, online gaming and entertainment services, and continued strong exclusive content f rom our own f irst-party game f ranchises as well as other digital content of f erings. Our search business competes with Google and a wide array of websites, social platf orms like Facebook, and portals that provide content and online of f erings to end users. 19 OPERATIONS We have operations centers that support operations in their regions, including customer contract and order processing, credit and collections, inf ormation processing, and vendor management and logistics. The regional center in Ireland supports the European, Middle Eastern, and Af rican region; the center in Singapore supports the Japan, India, Greater China, and Asia-Pacif ic 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 datacenters throughout the Americas, Europe, Australia, and Asia, as well as in the Middle East and Af rica. 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 ref lect local languages and conventions. Localizing a product may require modif ying the user interf ace, altering dialog boxes, and translating text. Our devices are primarily manuf actured by third -party contract manuf acturers. We generally have the ability to use other manuf acturers if a current vendor becomes unavailable or unable to meet our requirements. The majority of our hardware products contain components f or which there is only one qualif ied supplier. Extended disruptions at these suppliers could lead to a similar disruption in our ability to manuf acture devices. Product and Service Development, and Intellectual Property We develop most of our products and services internally through the f ollowing engineering groups. RESEARCH AND DEVELOPMENT • Cloud and AI, f ocuses on making IT prof essionals, developers, and their systems more productive and ef f icient through development of cloud inf rastructure, server, database, CRM, ERP, management and development tools, AI cognitive services, and other business process applications and services f or enterprises. • Experiences and Devices, f ocuses on instilling a unif ying product ethos across our end -user experiences and devices, including Of f ice, Windows, Enterprise Mobility + Security, and Surf ace. • AI and Research, f ocuses on our AI innovations and other f orward -looking research and development ef f orts spanning inf rastructure, services, applications, and search. LinkedIn, f ocuses on our services that transf orm the way customers hire, market, sell, and learn. • • Gaming, f ocuses on developing hardware, content, and services across a large range of platforms to help grow our user base through game experiences and social interaction. Internal development allows us to maintain competitive advantages that come f rom product dif f erentiation and closer technical control over our products and services. It also gives us the f reedom to decide which modif ications and enhancements are most important and when they should be implemented. We strive to obtain inf ormation as early as possible about changing usage patterns and hardware advanc es that may af f ect sof tware and hardware design. Bef ore releasing new sof tware platf orms, and as we make signif icant modif ications to existing platf orms, we provide application vendors with a range of resources and guidelines f or 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 enf orcement of copyright, trademark, trade secret, and other protections that apply to our sof tware and hardware products, services, business plans, and branding. We are a leader among technology companies in pursuing patents and currently have a portf olio of over 63,000 U.S. and international patents issued and over 24,500 pending worldwide. While we employ much of our internally-developed intellectual property exclusively in our products and services, we also engage in outbound licensing of specific patented technologies that are incorporated into licensees’ products. From time to time, we enter into broader cross-license agreements with other technology 20 companies covering entire groups of patents. We also purchase or license technology that we incorporate into our products and 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. Our increasing engagement with open source sof tware will also cause us to license our intellectual property rights broadly in certain situations. While it may be necessary in the f uture to seek or renew licenses relating to various aspects of our products, services, and business methods, we believe, based upon past experience and industry practice, such licenses generally can 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 Our success is based on our ability to create new and compelling products, services, and experiences f or 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 of fer signif icant opportunities to deliver value to our customers and growth f or the Company. Based on our assessment of key technology trends, we maintain our long -term commitment to research and development across a wide spectrum of technologies, tools, and platf orms spanning digital work and lif e ex periences, cloud computing, AI, devices, and operating systems. While our main product research and development f acilities are located in Redmond, Washington, we also operate researc h and development f acilities in other parts of the U.S. and around the wo rld, including Canada, China, Czech Republic, 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 f rom across the world. In addition to our main research and development operations, we also operate Microsof t Research. Microsof t Research is one of the world’s largest corporate research organizations and works in close collaboration with top universities around the world to advance the state-of -the-art in computer science and a broad range of other disciplines, providing us a unique perspective on f uture trends and contributing to our innovation. We generally f und research at the corporate level to ensure that we are looking beyond immediate product considerations to opportunities f urther in the f uture. We also f und research and development activities at the operating segment level. Much of our segment level research and development is coordinated with other segments and leveraged across the Company. We plan to continue to make signif icant investments in a broad range of research and development ef f orts. DISTRIBUTION, SALES, AND MARKETING We market and distribute our products and services through the f ollowing channels: OEMs, direct, and distributors and resellers. Our sales f orce perf orms a variety of f unctions, including working directly with commercial enterprises and public - sector organizations worldwide to identif y and meet their technology and digital transf ormation requirements; managing OEM relationships; and supporting system integrators, independent sof tware vendors, and other partners who engage directly with our customers to perf orm sales, consulting, and f ulf illment f unctions f or our products and services. OEMs We distribute our products and services through OEMs that pre-install our sof tware on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on devices. OEMs also sell devices pre-installed with other Microsof t products and services, including applications such as Of f ice and the capability to subscribe to Of f ice 365. 21 There are two broad categories of OEMs. The largest category of OEMs are direct OEMs as our relationship with them is managed through a direct agreement between Microsof t and the OEM. We have distribution agreements covering one or more of our products with virtually all the multinational OEMs, including Acer, ASUS, Dell, Fujitsu, Hewlett-Packard, Lenovo, Samsung, Sharp, Toshiba, and with many regional and local OEMs. The second broad category of OEMs are system builders consisting of lower-volume PC manuf acturers, which source Microsof t so f tware f or pre-installation and local redistribution primarily through the Microsof t distributor channel rather than through a direct agreement or relationship wit h Microsof t. Direct Many organizations that license our products and services transact directly with us through Enterprise Agreements and Enterprise Services contracts, with sales support f rom system integrators, independent sof tware vendors, web agencies, and partners that advise organizations on licensing our products and services (“Enterprise Agreement Sof tware Advisors” or “ESA”). Microsof t offers direct sales programs targeted to reach small, medium, and corporate customers, in addition to those of f ered through the reseller channel. A large network of partner advisors support many of these s ales. We also sell commercial and consumer products and services directly to customers, such as cloud services, search, and gaming, through our digital marketplaces and online stores. In June 2020, we announced a strategic change in our retail operations, including closing our Microsof t Store physical locations. Distributors and Resellers Organizations also license our products and services indirectly, primarily through licensing solution partners (“LSP”), distributors, value-added resellers (“VAR”), and retailers. Although each type of reselling partner may reach organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small and medium organizations. ESAs are also typ ically authorized as LSPs and operate as resellers f or our other volume licensing programs. Microsof t Cloud Solution Provider is our main partner program f or reselling cloud 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. We distribute our devices through third-party retailers. We have a network of f ield sales representatives and f ield support personnel that solicit orders f rom distributors and resellers, and provide product training and sales support. Our Dynamics business solutions are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services. LICENSING OPTIONS We of f er options f or organizations that want to purchase our cloud services, on-premises sof tware, and Sof tware Assurance. We license sof tware to organizations under volume licensing agreements to allow the customer to acquire multiple licenses of products and services instead of having to acquire separate licenses through retail channels. We use dif f erent programs designed to provide f lexibility f or organizations of various sizes. While these programs may dif fer in various parts of the world, generally they include those discussed below. SA conveys rights to new sof tware and upgrades f or perpetual licenses released o ver the contract period. It also provides support, tools, training, and other licensing benef its to help customers deploy and use sof tware ef f iciently. SA is included with certain volume licensing agreements and is an optional purchase with others. 22 Volume Licensing Programs Enterprise Agreement Enterprise Agreements of f er large organizations a manageable volume licensing program that gives them the f lexibility to buy cloud services and sof tware licenses under one agreement. Enterprise Agreements are designed f or medium or large organizations that want to license cloud services and on-premises sof tware organization-wide over a three-year period. Organizations can elect to purchase perpetual licenses or subscribe to licenses. SA is included. Microsoft Product and Services Agreement Microsof t Product and Services Agreements are designed f or medium and large organizations that want to license cloud services and on-premises sof tware as needed, with no organization-wide commitment, under a single, non-expiring agreement. Organizations purchase perpetual licenses or subscribe to licenses. SA is optional f or customers that purchase perpetual licenses. Open Open agreements are a simple, cost-ef f ective way to acquire the latest Microsof t technology. Open agreements are designed f or small and medium organizations that want to license cloud services and on-premises sof tware over a one- to three-year period. Under the Open agreements, organizations purchase perpetual licenses and SA is optional. Under Open Value agreements, organizations can elect to purchase perpetual licenses or subscribe to licenses and SA is included. Select Plus Select Plus agreements are designed f or government and academic organizations to acquire on -premises licenses at any af f iliate or department level, while realizing advantages as one organization. Organizations purchase perpetual licenses and SA is optional. Microsoft Online Subscription Agreement Microsof t Online Subscription Agreements are designed f or small and medium organizations that want to subscribe to, activate, provision, and maintain cloud services seamlessly and directly via the web. The agreement allows customers to acquire monthly or annual subscriptions f or cloud -based services. Partner Programs The Microsof t Cloud Solution Provider program of f ers customers an easy way to license the cloud services they need in combination with the value-added services of f ered by their systems integrator, managed services provider, or cloud reseller partner. Partners in this program can easily package their own products and servic es to directly provision, manage, and support their customer subscriptions. The Microsof t Services Provider License Agreement allows hosting service providers and independent sof tware vendors who want to license eligible Microsof t software products to pro vide sof tware services and hosted applications to their end customers. Partners license sof tware over a three-year period and are billed monthly based on consumption. The Independent Sof tware Vendor Royalty program enables partners to integrate Microsof t products into other applications and then license the unif ied business solution to their end users. 23 Our customers include individual consumers, small and medium organizations, large global enterprises, public -sector institutions, Internet service providers, application developers, and OEMs. Our practice is to ship our products promptly upon receipt of purchase orders f rom customers; consequently, backlog is not signif icant. CUSTOMERS EMPLOYEES As of June 30, 2020, we employed approximately 163,000 people on a f ull-time basis, 96,000 in the U.S. and 67,000 internationally. Of the total employed people, 56,000 were in operations, including manuf acturing, distribution, product support, and consulting services; 55,000 were in product research and developm ent; 40,000 were in sales and marketing; and 12,000 were in general and administration. Certain of our employees are subject to collective bargaining agreements. AVAILABLE INFORMATION Our Internet address is www.microsof t.com. At our Investor Relations website, www.microsof t.com/investor, we make available f ree of charge a variety of inf ormation f or investors. Our goal is to maintain the Investor Relations website as a portal through which investors can easily f ind or navigate to pertinent inf ormation 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 af ter we electronically f ile that material with or f urnish it to the Securities and Exchange Commission (“SEC”) at www.sec.gov. Inf ormation on our business strategies, f inancial results, and metrics f or investors. • • Announcements of investor conf erences, 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 inf ormation including our articles of incorporation, bylaws, governance guidelines, committee charters, codes of conduct and ethics, global corporate social responsibility initiatives, and other governance-related policies. • Other news and announcements that we may post f rom time to time that investors might f ind usef ul or interesting. • Opportunities to sign up f or email alerts to have inf ormation pushed in real time. The inf ormation f ound on our website is not part of this or any other report we f ile with, or f urnish to, the SEC. In additio n to these channels, we use social media to communicate to the public. It is possible that the inf ormation we post on social media could be deemed to be material to investors. We encourage investors, the media, and others interested in Microsoft to review the inf ormation we post on the social media channels listed on our Investor Relations website. 24 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The f ollowing Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand the results of operations and f inancial condition of Microsoft Corporation. MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated f inancial statements and the accompanying Notes to Financial Statements. OVERVIEW Microsof t is a technology company whose mission is to empower every person and every organization on the planet to achieve more. We strive to create local opportunity, growth, and impact in every country around the world. Our platf orms and tools help drive small business productivity, large business competitiveness, and public -sector ef f iciency. They also support new startups, improve educational and health outcomes, and empower human ingenuity. We generate revenue by of f ering a wide range of cloud-based and other services to people and businesses; licensing and supporting an array of sof tware products; designing, manuf acturing, and selling devices; and delivering relevant online advertising to a global audience. Our most signif icant expenses are related to compensating employees; designing, manuf acturing, marketing, and selling our products and services; datacenter costs in support of our cloud -based services; and income taxes. As the world responds to the outbreak of a novel strain of the coronavirus (“COVID-19”), we are working to do our part by ensuring the saf ety of our employees, striving to protect the health and well-being of the communities in which we operate, and providing technology and resources to our customers to help them do their best work while remote. Highlights f rom f iscal year 2020 compared with f iscal year 2019 included: • Commercial cloud revenue increased 36% to $51.7 billion. • Of f ice Commercial products and cloud services revenue increased 12%, driven by Of f ice 365 Commercial growth of 24%. • Of f ice Consumer products and cloud services revenue increased 11%, with continued growth in Of f ice 365 Consumer subscribers to 42.7 million. LinkedIn revenue increased 20%. • • Dynamics products and cloud services revenue increased 14%, driven by Dynamic s 365 growth of 42%. • Server products and cloud services revenue increased 27%, driven by Azure growth of 56%. • Enterprise Services revenue increased 5%. • Windows Commercial products and cloud services revenue increased 18%. • Windows original equipment manuf acturer licensing (“Windows OEM”) revenue increased 9%. • Surf ace revenue increased 8%. • Xbox content and services revenue increased 11%. • Search advertising revenue, excluding traf f ic acquisition costs, was relatively unchanged. Industry Trends Our industry is dynamic and highly competitive, with f requent changes in both technologies and business models. Each industry shif t is an opportunity to conceive new products, new technologies, or new ideas that can f urther 25 transf orm the industry and our business. At Microsof t, we push the boundaries of what is possible through a broad range of research and development activities that seek to identif y and address the changing demands of customers and users, industry trends, and competitive f orces. Economic Conditions, Challenges, and Risks The markets f or sof tware, devices, and cloud -based services are dynamic and highly competitive. Our competitors are developing new sof tware and devices, while also deploying competing cloud -based services f or consumers and businesses. The devices and f orm f actors customers pref er evolve rapidly, and inf luence how users access services in the cloud, and in some cases, the user’s choice of which suite of cloud -based services to use. We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in inf rastructure and devices will continue to increase our operating costs and may decrease our operating margins. Our success is highly dependent on our ability to attract and retain qualif ied employees. We hire a mix of university and industry talent worldwide. We compete f or talented individuals globally by of f ering an exceptional working environment, broad customer reach, scale in resources, the ability to grow one’s career across many dif f erent products and businesses, and competitive compensation and benef its. Aggregate demand f or our sof tware, services, and devices is correlated to global macroeconomic and geopolitical f actors, which remain dynamic. Our international operations provide a signif icant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.S. dollar. As a result, changes in f oreign exchange rates may signif icantly af f ect revenue and expenses. Strengthening of the U.S. dollar relative to certain f oreign currencies did not signif icantly impact reported revenue or expenses f rom our international operations in the f irst and second quarters of f iscal year 2019, and reduced reported revenue and expenses f rom our international operations in the third and f ourth quarters of f iscal year 2019. Strengthening of the U.S. dollar relative to certain f oreign currencies reduced reported revenue and expenses f rom our international operations in f iscal year 2020. Ref er to Risk Factors in our f iscal year 2020 Form 10-K f or a discussion of these f actors and other risks. COVID-19 In f iscal year 2020, the COVID-19 pandemic impacted our business operations, including our employees, customers, partners, and communities, and we saw the f ollowing trends in our f inancial operating results. In the Productivity and Business Processes and Intelligent Cloud segments, cloud usage and demand increased as customers shif ted to work and learn f rom home. We also experienced a slowdown in transactional licensing, particularly in small and medium businesses, and LinkedIn was negatively impacted by the weak job market and reductions in advertising spend. In the More Personal Computing segment, Windows OEM, Surf ace, and Gaming benef ited f rom increased demand to support remote work -, play-, and learn-f rom-home scenarios, while Search was negatively impacted by reductions in advertising spend. The COVID-19 pandemic may continue to impact our business operations and f inancial operating results, and there is substantial uncertainty in the nature and degree of its continued ef f ects over time. The extent to which the COVID-19 pandemic impacts our business going f orward will depend on numerous evolving f actors we cannot reliably predict, including the duration and scope of the pandemic; governmental, business, and individuals’ actions in response to the pandemic; and the impact on economic activity including the possibility of recession or f inancial market instability. These f actors may adversely impact consumer, business, and government spending on technology as well as customers’ ability to pay f or our products and services on an ongoing basis. This uncertainty also af f ects management’s accounting estimates and assumptions, which could result in greater variability in a variety of areas that depend on these estimates and assumptions, including investments, receivables, and f orward -looking guidance. Ref er to Risk Factors in our f iscal year 2020 Form 10-K f or a discussion of these f actors and other risks. Seasonality Our revenue f luctuates quarterly and is generally higher in the second and f ourth quarters of our f iscal year. Second quarter revenue is driven by corporate year-end spending trends in our major markets and holiday season spending 26 by consumers, and f ourth quarter revenue is driven by the volume of multi-year on-premises contracts executed during the period. Reportable Segments We report our f inancial perf ormance based on the f ollowing segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. The segment amounts included in MD&A are presented on a basis consistent with our internal management reporting. All dif f erences between our internal management reporting basis and accounting principles generally accepted in the United States of America (“GAAP”), along with certain corporate-level and other activity, are included in Corporate and Other. Additional inf ormation on our reportable segments is contained in Note 19 – Segment Inf ormation and Geographic Data of the Notes to Financial Statements. Metrics We use metrics in assessing the perf ormance of our business and to make inf ormed decisions re garding the allocation of resources. We disclose metrics to enable investors to evaluate progress against our ambitions, provide transparency into perf ormance trends, and ref lect the continued evolution of our products and services. Our commercial and othe r business metrics are f undamentally connected based on how customers use our products and services. The metrics are disclosed in the MD&A or the Notes to Financial Statements. Financial metrics are calculated based on GAAP results and growth comparisons relate to the corresponding period of last f iscal year. Commercial Our commercial business primarily consists of Server products and cloud services, Of f ice Commercial, Windows Commercial, the commercial portion of LinkedIn, Enterprise Services, and Dynami cs. Our commercial metrics allow management and investors to assess the overall health of our commercial business and include leading indicators of f uture perf ormance. Commercial remaining perf ormance obligation Commercial cloud revenue Commercial cloud gross margin percentage Commercial portion of revenue allocated to remaining perf ormance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in f uture periods Revenue f rom our commercial cloud business, which includes Of f ice 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties Gross margin percentage f or our commercial cloud business Productivity and Business Processes and Intelligent Cloud Metrics related to our Productivity and Business Processes and Intelligent Cloud segments assess the health of our core businesses within these segments. The metrics ref lect our cloud and on-premises product strategies and trends. Of f ice Commercial products and cloud services revenue growth Of f ice Consumer products and cloud services revenue growth Revenue f rom Of f ice Commercial products and cloud services, including Of f ice 365 subscriptions, the Of f ice 365 portion of Microsoft 365 Commercial subscriptions, and Of f ice licensed on-premises, comprising Of f ice, Exchange, SharePoint, Microsof t Teams, Of f ice 365 Security and Compliance, and Skype f or Business, and related Client Access Licenses (“CALs”) Revenue f rom Of f ice Consumer products and cloud services, including Microsof t 365 Consumer (f ormerly Of f ice 365 Consumer) subscriptions and Of f ice licensed on-premises 27 Of f ice 365 Commercial seat growth Of f ice 365 Consumer subscribers Dynamics products and cloud services revenue growth LinkedIn revenue growth Server products and cloud services revenue growth Enterprise Services revenue growth The number of Of f ice 365 Commercial seats at end of period where seats are paid users covered by an Of f ice 365 Commercial subscription The number of Of fice 365 Consumer subscribers at end of period Revenue f rom Dynamics products and cloud services, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises Revenue f rom LinkedIn, including Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions Revenue f rom Server products and cloud services, including Azure; SQL Server, Windows Server, Visual Studio, System Center, and related CALs; and GitHub Revenue f rom Enterprise Services, including Premier Support Services and Microsof t Consulting Services More Personal Computing Metrics related to our More Personal Computing segment assess the perf ormance of key lines of business within this segment. These metrics provide strategic product insights which allow us to assess the perf ormance across our commercial and consumer businesses. As we have diversity of target audiences and sales motions within the Windows business, we monitor metrics that are ref lective of those varying motions. Windows OEM Pro revenue growth Windows OEM non-Pro revenue growth Windows Commercial products and cloud services revenue growth Surf ace revenue Xbox content and services revenue growth Revenue f rom sales of Windows Pro licenses sold through the OEM channel, which primarily addresses demand in the commercial market Revenue f rom sales of Windows non-Pro licenses sold through the OEM channel, which primarily addresses demand in the consumer market Revenue f rom Windows Commercial products and cloud services, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial of ferings Revenue f rom Surf ace devices and accessories Revenue f rom Xbox content and services, comprising Xbox Live (transactions, subscriptions, cloud services, and advertising), video games, and third-party video game royalties Search advertising revenue, excluding TAC, growth Revenue f rom search advertising excluding traf f ic acquisition costs (“TAC”) paid to Bing Ads network publishers SUMMARY RESULTS OF OPERATIONS (In millions, except percentages and per share amounts) 2020 2019 2018 Percentage Change 2020 Versus 2019 Percentage Change 2019 Versus 2018 Revenue Gross margin Operating income Net income Diluted earnings per share Non-GAAP net income Non-GAAP diluted earnings per share $ 143,015 96,937 52,959 44,281 5.76 44,281 5.76 $ 125,843 82,933 42,959 39,240 5.06 36,830 4.75 $ 110,360 72,007 35,058 16,571 2.13 30,267 3.88 14% 17% 23% 13% 14% 20% 21% 14% 15% 23% 137% 138% 22% 22% 28 Non-GAAP net income and diluted earnings per share (“EPS”) exclude the net tax impact of transf er of intangible properties in f iscal year 2019 and the net tax impact of the Tax Cuts and Jobs Act (“TCJA”) in f iscal years 2019 and 2018. Ref er to the Non-GAAP Financial Measures section below f or a reconciliation of our f inancial results reported in accordance with GAAP to non-GAAP f inancial results. Fiscal Year 2020 Compared with Fiscal Year 2019 Revenue increased $17.2 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue increased, driven by server products and cloud services. Productivity and Business Processes revenue increased, driven by Of f ice Commercial and LinkedIn. More Personal Computing revenue increased, driven by Windows and Surf ace. Gross margin increased $14.0 billion or 17%, driven by growth across each of our segments. Gross margin percentage increased, driven by sales mix shif t to higher margin businesses. Commercial cloud gross margin percentage increased 4 points to 67%, primarily driven by improvement in Azure. Operating income increased $10.0 billion or 23%, driven by growth across each of our segments. Key changes in expenses were: • Cost of revenue increased $3.2 billion or 7%, driven by growth in commercial cloud. • Research and development expenses increased $2.4 billion or 14%, driven by investments in cloud engineering, LinkedIn, Devices, and Gaming. • Sales and marketing expenses increased $1.4 billion or 8%, driven by investments in LinkedIn and commercial sales, and an increase in bad debt expense. • General and administrative expenses increased $226 million or 5%, driven by charges associated with the closing of our Microsof t Store physical locations, of f set in part by a reduction in business taxes and legal expenses. Gross margin and operating income included an unf avorable f oreign currency impact of 2% and 4%, respectively. Prior year net income included a $2.6 billion net income tax benef it related to intangible property transf ers and a $157 million net charge related to the enactment of the TCJA, which together resulted in an increase to net income and diluted EPS of $2.4 billion and $0.31, respectively. Fiscal Year 2019 Compared with Fiscal Year 2018 Revenue increased $15.5 billion or 14%, driven by growth across each of our segments. Intelligent Cloud revenue increased, driven by server products and cloud services. Productivity and Business Processes revenue increased, driv en by Of f ice and LinkedIn. More Personal Computing revenue increased, driven by Surf ace, Gaming, and Windows. Gross margin increased $10.9 billion or 15%, driven by growth across each of our segments. Gross margin percentage increased slightly, due to gross margin percentage improvement across each of our segments and f avorable segment sales mix. Gross margin included a 5 percentage point improvement in commercial cloud, primarily f rom Azure. Operating income increased $7.9 billion or 23%, driven by growth across each of our segments. Key changes in expenses were: • Cost of revenue increased $4.6 billion or 12%, driven by growth in commercial cloud, Surf ace, and Gaming. • Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and artif icial intelligence (“AI”) engineering, Gaming, LinkedIn, and GitHub. 29 • Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, of f set in part by a decrease in marketing. Sales and marketing expenses included a f avorable f oreign currency impact of 2%. Fiscal year 2019 net income included a $2.6 billion net income tax benef it related to intangible property transf ers and a $157 million net charge related to the enactment of the TCJA, which together resulted in an increase to net income and diluted EPS of $2.4 billion and $0.31, respectively. Fiscal year 2018 net income and diluted EPS were negatively impacted by the net charge related to the enactment of the TCJA, which resulted in a decrease to net income and diluted EPS of $13.7 billion and $1.75, respectively. (In millions, except percentages) Revenue Productivity and Business Processes Intelligent Cloud More Personal Computing Total Operating Income Productivity and Business Processes Intelligent Cloud More Personal Computing Total SEGMENT RESULTS OF OPERATIONS 2020 2019 2018 Percentage Change 2020 Versus 2019 Percentage Change 2019 Versus 2018 $ 46,398 48,366 48,251 $ 143,015 $ 41,160 $ 38,985 45,698 35,865 32,219 42,276 $ 125,843 $ 110,360 $ $ 18,724 18,324 15,911 52,959 $ $ 16,219 $ 13,920 12,820 42,959 $ 12,924 11,524 10,610 35,058 13% 24% 6% 14% 15% 32% 24% 23% 15% 21% 8% 14% 25% 21% 21% 23% Reportable Segments Fiscal Year 2020 Compared with Fiscal Year 2019 Productivity and Business Processes Revenue increased $5.2 billion or 13%. • Of f ice Commercial products and cloud services revenue increased $3.1 billion or 12%, driven by Of f ice 365 Commercial, of f set in part by lower revenue f rom products licensed on-premises, ref lecting a continued shift to cloud of ferings. Of fice 365 Commercial revenue grew 24%, due to seat growth and higher revenue per user. • Of f ice Consumer products and cloud services revenue increased $458 million or 11%, driven by Microsof t 365 Consumer subscription revenue and transactional strength in Japan. Of f ice 365 Consumer subscribers increased 23% to 42.7 million with increased demand f rom remote work and learn scenarios. LinkedIn revenue increased $1.3 billion or 20%, driven by growth across all businesses. • • Dynamics products and cloud services revenue increased 14%, driven by Dynamics 365 growth of 42%. Operating income increased $2.5 billion or 15%. • Gross margin increased $4.1 billion or 13%, driven by growth in Of f ice Commercial and LinkedIn. Gross marg in percentage was relatively unchanged, due to gross margin percentage improvement in LinkedIn, of f set in part by an increased mix of cloud of ferings. • Operating expenses increased $1.6 billion or 11%, driven by investments in LinkedIn and cloud engineering. 30 Revenue, gross margin, and operating income included an unf avorable f oreign currency impact of 2%, 2%, and 4%, respectively. Intelligent Cloud Revenue increased $9.4 billion or 24%. • Server products and cloud services revenue increased $8.8 billion or 27%, driven by Azure. Azure revenue grew 56%, due to growth in our consumption-based services. Server products revenue increased 8%, due to hybrid and premium solutions, as well as demand related to SQL Server 2008 and Windows Server 2008 end of support. • Enterprise Services revenue increased $285 million or 5%, driven by growth in Premier Support Services. Operating income increased $4.4 billion or 32%. • Gross margin increased $6.9 billion or 26%, driven by growth in server products and cloud services revenue and cloud services scale and ef f iciencies. Gross margin percentage increased slightly, due to gross margin percentage improvement in Azure, of fset in part by an increased mix of cloud offerings. • Operating expenses increased $2.5 billion or 19%, driven by investments in Azure. Revenue, gross margin, and operating income included an unf avorable f oreign currency impact of 2%, 2%, and 4%, respectively. More Personal Computing Revenue increased $2.6 billion or 6%. • Windows revenue increased $1.9 billion or 9%, driven by growth in Windows Commercial and Windows OEM. Windows Commercial products and cloud services revenue increased 18%, driven by increased demand f or Microsof t 365. Windows OEM revenue increased 9%, ahead of PC market growth. Windows OEM Pro revenue grew 11%, driven by Windows 7 end of support and healthy Windows 10 demand, of f set in part by weakness in small and medium businesses. Windows OEM non-Pro revenue grew 5%, driven by consumer demand f rom remote work and learn scenarios. • Surf ace revenue increased $457 million or 8%, driven by increased demand f rom remote work and learn scenarios. • Gaming revenue increased $189 million or 2%, driven by an increase in Xbox content and services, of fset in part by a decrease in Xbox hardware. Xbox content and services revenue increased $943 million or 11% on a strong prior year comparable, driven by gro wth in Minecraf t, third-party titles, and subscriptions, accelerated by higher engagement during stay-at-home guidelines. Xbox hardware revenue declined 31%, primarily due to a decrease in volume and price of consoles sold. • Search advertising revenue increased $112 million or 1%. Search advertising revenue, excluding traf fic acquisition costs, was relatively unchanged. Operating income increased $3.1 billion or 24%. • Gross margin increased $3.0 billion or 12%, driven by growth in Windows, Gaming, and Surf ace. Gross margin percentage increased, due to sales mix shif t to higher margin businesses and gross margin percentage improvement in Gaming. • Operating expenses decreased $119 million or 1%, driven by the redeployment of engineering resources, of fset in part by charges associated with the closing of our Microsof t Store physical locations and investments in Gaming. Gross margin and operating income included an unf avorable f oreign currency impact of 2% and 3%, respectively. 31 Fiscal Year 2019 Compared with Fiscal Year 2018 Productivity and Business Processes Revenue increased $5.3 billion or 15%. • Of f ice Commercial products and cloud services revenue increased $3.2 billion or 13%, driven by Of f ice 365 Commercial, of f set in part by lower revenue f rom products licensed on-premises, ref lecting a continued shift to cloud of f erings. Of fice 365 Commercial grew 33%, due to growth in seats and higher average revenue per user. • Of f ice Consumer products and cloud services revenue increased $286 million or 7%, driven by Microsof t 365 Consumer, due to recurring subscription revenue and transactional strength in Japan. LinkedIn revenue increased $1.5 billion or 28%, driven by growth across each line of business. • • Dynamics products and cloud services revenue increased 15%, driven by Dynamics 365 growth. Operating income increased $3.3 billion or 25%, including an unf avorable f oreign currency impact of 2%. • Gross margin increased $4.1 billion or 15%, driven by growth in Of f ice Commercial and LinkedIn. Gross margin percentage increased slightly, due to gross margin percentage improvement in LinkedIn and Of f ice 365 Commercial, of fset in part by an increased mix of cloud offerings. • Operating expenses increased $806 million or 6%, driven by investments in LinkedIn and cloud engineering, of f set in part by a decrease in marketing. Intelligent Cloud Revenue increased $6.8 billion or 21%. • Server products and cloud services revenue, including GitHub, increased $6.5 billion or 25%, driven by Azure. Azure revenue growth was 72%, due to higher inf rastructure-as-a-service and platf orm-as-a-service consumption-based and per user-based services. Server products revenue increased 6%, due to continued demand f or premium versions and hybrid solutions, GitHub, and demand ahead of end -of -support f or SQL Server 2008 and Windows Server 2008. • Enterprise Services revenue increased $278 million or 5%, driven by growth in Premier Support Services and Microsof t Consulting Services. Operating income increased $2.4 billion or 21%. • Gross margin increased $4.8 billion or 22%, driven by growth in server products and cloud services revenue and cloud services scale and ef f iciencies. Gross margin percentage increased slightly, due to gross margin percentage improvement in Azure, of fset in part by an increased mix of cloud offerings. • Operating expenses increased $2.4 billion or 22%, driven by investments in clo ud and AI engineering, GitHub, and commercial sales capacity. More Personal Computing Revenue increased $3.4 billion or 8%. • Windows revenue increased $877 million or 4%, driven by growth in Windows Commercial and Windows OEM, of f set in part by a decline in patent licensing. Windows Commercial products and cloud services revenue increased 14%, driven by an increased mix of multi-year agreements that carry higher in-quarter revenue recognition. Windows OEM revenue increased 4%. Windows OEM Pro revenue grew 10%, ahead of the commercial PC market, driven by healthy Windows 10 demand. Windows OEM non-Pro revenue declined 7%, below the consumer PC market, driven by continued pressure in the entry level category. • Surf ace revenue increased $1.1 billion or 23%, with strong growth across commercial and consumer. 32 • Gaming revenue increased $1.0 billion or 10%, driven by Xbox sof tware and services growth of 19%, primarily due to third-party title strength and subscriptions growth, of f set in part by a decline in Xbox hardware of 13% primarily due to a decrease in volume of consoles sold. • Search advertising revenue increased $616 million or 9%. Search advertising revenue, excluding traf fic acquisition costs, increased 13%, driven by higher revenue per search. Operating income increased $2.2 billion or 21%, including an unf avorable f oreign currency impact of 2%. • Gross margin increased $2.0 billion or 9%, driven by growth in Windows, Gaming, and Search. Gross margin percentage increased slightly, due to sales mix shif t to higher gross margin businesses in Windows and Gaming. • Operating expenses decreased $172 million or 1%. OPERATING EXPENSES Research and Development (In millions, except percentages) Research and development As a percent of revenue 2020 2019 2018 Percentage Change 2020 Versus 2019 Percentage Change 2019 Versus 2018 $ 19,269 13% $ 16,876 13% $ 14,726 13% 14% 0ppt 15% 0ppt Research and development expenses include payroll, employee benef its, 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 sof tware f or international markets, and the amortization of purchased sof tware code and services content. Fiscal Year 2020 Compared with Fiscal Year 2019 Research and development expenses increased $2.4 billion or 14%, driven by investments in cloud engineering, LinkedIn, Devices, and Gaming. Fiscal Year 2019 Compared with Fiscal Year 2018 Research and development expenses increased $2.2 billion or 15%, driven by investments in cloud and AI engineering, Gaming, LinkedIn, and GitHub. Sales and Marketing (In millions, except percentages) Sales and marketing As a percent of revenue 2020 2019 2018 $ 19,598 14% $ 18,213 14% $ 17,469 16% Percentage Change 2020 Versus 2019 8% 0ppt Percentage Change 2019 Versus 2018 4% (2)ppt Sales and marketing expenses include payroll, employee benef its, 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 2020 Compared with Fiscal Year 2019 Sales and marketing expenses increased $1.4 billion or 8%, driven by investments in LinkedIn and commercial sales, and an increase in bad debt expense. 33 Fiscal Year 2019 Compared with Fiscal Year 2018 Sales and marketing expenses increased $744 million or 4%, driven by investments in commercial sales capacity, LinkedIn, and GitHub, of f set in part by a decrease in marketing. Expenses included a f avorable f oreign currency impact of 2%. General and Administrative (In millions, except percentages) General and administrative As a percent of revenue 2020 2019 2018 Percentage Change 2020 Versus 2019 Percentage Change 2019 Versus 2018 $ 5,111 4% $ 4,885 4% $ 4,754 4% 5% 0ppt 3% 0ppt General and administrative expenses include payroll, employee benef its, stock -based compensation expense, severance expense, and other headcount-related expenses associated with f inance, legal, f acilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative f ees. Fiscal Year 2020 Compared with Fiscal Year 2019 General and administrative expenses increased $226 million or 5%, driven by charges associated with the closing of our Microsof t Store physical locations, offset in part by a reduction in business taxes and legal expenses. Fiscal Year 2019 Compared with Fiscal Year 2018 General and administrative expenses increased $131 million or 3%. The components of other income (expense), net were as f ollows: OTHER INCOME (EXPENSE), NET (In millions) Year Ended June 30, Interest and dividends income Interest expense Net recognized gains on investments Net gains (losses) on derivatives Net losses on f oreign currency remeasurements Other, net Total 2020 2019 (2,686) 2018 $ 2,680 $ 2,762 $ 2,214 (2,733) 648 2,399 (187) 144 (82) (218) (59) (57) 729 $ 1,416 (2,591) 32 187 (191) (40) 77 $ $ We use derivative instruments to: manage risks related to f oreign currencies, equity prices, interest rates, and credit; enhance investment returns; and f acilitate portf olio diversif ication. Gains and losses f rom changes in f air values of derivatives that are not designated as hedging instruments are primarily recognized in other income (expense), net. Fiscal Year 2020 Compared with Fiscal Year 2019 Interest and dividends income decreased due to lower yields, of f set in part by higher average portf olio bal ances on f ixed- income securities. Interest expense decreased due to capitalization of interest expense and a decrease in outstanding long - term debt due to debt maturities, of f set in part by debt exchange transaction f ees and higher f inance lease expense. N et recognized gains on investments decreased due to lower gains and higher other-than- 34 temporary impairments on equity investments, of fset in part by gains on f ixed income securities in the current period compared to losses in the prior period. Net gains on derivatives increased due to higher gains on f oreign exchange and equity derivatives. Fiscal Year 2019 Compared with Fiscal Year 2018 Interest and dividends income increased primarily due to higher yields on f ixed -income securities. Interest expense decreased primarily driven by a decrease in outstanding long -term debt due to debt maturities, of f set in part by higher f inance lease expense. Net recognized gains on investments decreased primarily due to lower gains on sales of equity investments. Net gains on derivatives includes gains on f oreign exchange and interest rate derivatives in the current period as compared to losses in the prior period. Effective Tax Rate Fiscal Year 2020 Compared with Fiscal Year 2019 INCOME TAXES Our ef f ective tax rate f or f iscal years 2020 and 2019 was 17% and 10%, respectively. The increase in our ef f ective tax rate f or f iscal year 2020 compared to f iscal year 2019 was primarily due to a $2.6 billion net income tax benef it in the f ourth quarter of f iscal year 2019 related to intangible property transf ers. Our ef f ective tax rate was lower than the U.S. f ederal statutory rate, primarily due to earnings taxed at lower rates in f oreign jurisdictions res ulting f rom producing and distributing our products and services through our f oreign regional operations centers in Ireland and Puerto Rico, and tax benef its relating to stock-based compensation. The mix of income bef ore income taxes between the U.S. and f oreign countries impacted our ef f ective tax rate as a result of the geographic distribution of, and customer demand f or, our products and services. In f iscal year 2020, our U.S. income bef ore income taxes was $24.1 billion and our f oreign income bef ore income taxes was $28.9 billion. In f iscal year 2019, our U.S. income bef ore income taxes was $15.8 billion and our f oreign income bef ore income taxes was $27.9 billion. Fiscal Year 2019 Compared with Fiscal Year 2018 Our ef f ective tax rate f or f iscal years 2019 and 2018 was 10% and 55%, respectively. The decrease in our ef f ective tax rate f or f iscal year 2019 compared to f iscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of f iscal year 2018 and a $2.6 billion net income tax benef it in the f ourth quarter of f iscal year 2019 related to intangible property transf ers. Our ef f ective tax rate was lower than the U.S. f ederal statutory rate, primarily du e to the tax benef it related to intangible property transf ers, and earnings taxed at lower rates in f oreign jurisdictions resulting f rom producing and distributing our products and services through our f oreign regional operations centers in Ireland, Singapore, and Puerto Rico. The mix of income bef ore income taxes between the U.S. and f oreign countries impacted our ef f ective tax rate as a result of the geographic distribution of, and customer demand f or, our products and services. In f iscal year 2019, our U.S. income bef ore income taxes was $15.8 billion and our f oreign income bef ore income taxes was $27.9 billion. In f iscal year 2018, our U.S. income bef ore income taxes was $11.5 billion and our f oreign income bef ore income taxes was $24.9 billion. Tax Cuts and Jobs Act On December 22, 2017, the TCJA was enacted into law, which signif icantly changed existing U.S. tax law and included numerous provisions that af f ect our business. We recorded a provisional net charge of $13.7 billion related to the enactment of the TCJA in f iscal year 2018, and adjusted the p rovisional net charge by recording additional tax expense of $157 million in f iscal year 2019 pursuant to Securities and Exchange Commission Staf f Accounting Bulletin No. 118. 35 In f iscal year 2019, in response to the TCJA and recently issued regulations, we transf erred certain intangible properties held by our f oreign subsidiaries to the U.S. and Ireland. The transf ers of intangible properties resulted in a $2.6 billion net income tax benef it recorded in the f ourth quarter of f iscal year 2019, as the value of f uture tax deductions exceeded the current tax liability f rom f oreign jurisdictions and U.S. global intangible low-taxed income tax. Ref er to Note 12 – Income Taxes of the Notes to Financial Statements f or f urther discussion. Uncertain Tax Positions We settled a portion of the Internal Revenue Service (“IRS”) audit f or tax years 2004 to 2006 in f iscal year 2011. In Februar y 2012, the IRS withdrew its 2011 Revenue Agents Rep ort related to unresolved issues f or tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit f or tax years 2007 to 2009 in f iscal year 2016, and a portion of the IRS audit f or tax years 2010 to 2013 in f iscal year 2018. We remain under audit f or tax years 2004 to 2013. In April 2020, the IRS commenced the audit f or tax years 2014 to 2017. As of June 30, 2020, the primary unresolved issues f or the IRS audits relate to transf er pricing, which could have a material impact in our consolidated f inancial statements when the matters are resolved. We believe our allowances f or income tax contingencies are adequate. We have not received a proposed assessment f or the unresolved issues and do not expect a f inal resolution of these issues in the next 12 months. Based on the inf ormation currently available, we do not anticipate a signif icant increase or decrease to our tax contingencies f or these issues within the next 12 months. We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination f or tax years 1996 to 2019, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated f inancial statements. NON-GAAP FINANCIAL MEASURES Non-GAAP net income and diluted EPS are non-GAAP f inancial measures which exclude the net tax impact of transf er of intangible properties in f iscal year 2019 and the net tax impact of the TCJA in f iscal years 2019 and 2018. We believe these non-GAAP measures aid investors by providing additional insight into our operational perf ormance and help clarif y trends af f ecting our business. For comparability of reporting, management considers non-GAAP measures in conjunction with GAAP f inancial results in evaluating business perf ormance. These non-GAAP f inancial measures presented should not be considered a substitute f or, or superior to, the measures of f inancial perf ormance prepared in accordance with GAAP. The f ollowing table reconciles our f inancial results reported in accordance with GAAP to non-GAAP f inancial results: 2020 2019 0 0 2018 $ 44,281 $ 39,240 $ 16,571 (2,567) 0 13,696 157 $ 44,281 $ 36,830 $ 30,267 2.13 0 1.75 3.88 5.06 $ (0.33) 0.02 4.75 $ 5.76 $ 0 0 5.76 $ $ $ Percentage Change 2020 Versus 2019 13% * * 20% 14% * * 21% Percentage Change 2019 Versus 2018 137% * * 22% 138% * * 22% (In millions, except percentages and per share amounts) Net income Net tax impact of transf er of intangible properties Net tax impact of the TCJA Non-GAAP net income Diluted earnings per share Net tax impact of transf er of intangible properties Net tax impact of the TCJA Non-GAAP diluted earnings per share * Not meaningful. 36 Cash, Cash Equivalents, and Investments FINANCIAL CONDITION Cash, cash equivalents, and short-term investments totaled $136.5 billion and $133.8 billion as of June 30, 2020 and 2019. Equity investments were $3.0 billion and $2.6 billion as of June 30, 2020 and 2019, respectively. Our short-term investments are primarily intended to f acilitate liquidity and capital preservation. They consist predominantly of highly liquid investment - grade f ixed-income securities, diversif ied among industries and individual issuers. The investments are predominantly U.S. dollar-denominated securities, but also include f oreign currency -denominated securities to diversif y risk. Our f ixed -income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our f ixed -income portf olio are managed to achieve economic returns that correlate to certain f ixed -income indices. The settlement risk related to these investments is insignif icant given that the short-term investments held are primarily highly liquid investment -grade f ixed- income securities. Valuation In general, and where applicable, we use quoted prices in active markets f or identical assets or liabilities to determine the f air value of our f inancial instruments. This pricing methodology applies to our Level 1 investments, such as U.S. government securities, common and pref erred stock, and mutual f unds. If quoted prices in active markets f or identical assets or liabilit ies are not available to determine f air value, then we use quoted prices f or similar assets and liabilities or inputs other tha n the quoted prices that are observable either directly or indirectly. This pricing methodology applies to our Level 2 investments, such as commercial paper, certif icates of deposit, U.S. agency securities, f oreign government bonds, mortgage - and asset- backed securities, corporate notes and bonds, and municipal securities. Level 3 investments are valued using internally- developed models with unobservable inputs. Assets and liabilities measured at f air value on a recurring basis using unobservable inputs are an immaterial portion of our portf olio. 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 f or their pricing without applying signif icant 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 ref lective of f air values in the market in which t he investment trades. Our broker-priced investments are generally classif ied as Level 2 investments because the broker prices these investments based on similar assets without applying signif icant adjustments. In addition, all our broker -priced investments have a suf f icient level of trading volume to demonstrate that the f air values used are appropriate f or these investments. Our f air value processes include controls that are designed to ensure appropriate f air values are recorded. These controls include model validation, review of key model inputs, analysis of period -over-period f luctuations, and independent recalculation of prices where appropriate. Cash Flows Fiscal Year 2020 Compared with Fiscal Year 2019 Cash f rom operations increased $8.5 billion to $60.7 billion f or f iscal year 2020, mainly due to an increase in cash f rom customers, of f set in part by an increase in cash used to pay income taxes, suppliers, and employees. Cash used in f inancing increased $9.1 billion to $46.0 billion f or f iscal year 2020, mainly due to a $3.4 billion cash premium on our debt exchange, a $3.4 billion increase in common stock repurchases, a $1.5 billion increase in repayments of debt, and a $1.3 billion increase in dividends paid. Cash used in investing decreased $3.6 billion to $12.2 billion f or f iscal year 2020, mainly due to a $6.4 billion increase in cash f rom net investment purchases, sales, and maturities, of f set in part by a $1.5 billion increase in additions to property and equipment and $1.2 billion in other investing to f acilitate the purchase of components. Fiscal Year 2019 Compared with Fiscal Year 2018 Cash f rom operations increased $8.3 billion to $52.2 billion f or f iscal year 2019, mainly due to an increase in cash received f rom customers, of fset in part by an increase in cash paid to suppliers and employees and an increase in 37 cash paid f or income taxes. Cash used in f inancing increased $3.3 billion to $36.9 billion f or f iscal year 2019, mainly due to an $8.8 billion increase in common stock repurchases and a $1.1 billion increase in dividends paid, of f set in part by a $6.2 billion decrease in repayments of debt, net of proceeds f rom issuance of debt. Cash used in investing increased $9.7 billion to $15.8 billion f or f iscal year 2019, mainly due to a $6.0 billion decrease in cash f rom net investment purchases, sales, and maturities, a $2.3 billion increase in additions to property and equipment, and a $1.5 billion increase in cash used f or acquisitions of companies, net of cash acquired, and purchases of intangible and other assets. Debt We issue debt to take advantage of f avorable pricing and liquidity in the debt markets, ref lecting our credit rating and the low interest rate environment. The proceeds of these issuances were or will be used f or general corporate purposes, which may include, among other things, f unding f or working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt. In June 2020, we exchanged a portion of our existing debt at premium f or cash and new debt with longer maturities to take advantage of f avorable f inancing rates in the debt markets, ref lecting our credit rating and the low interest rate environment. Ref er to Note 11 – Debt of the Notes to Financial Statements f or f urther discussion. Unearned Revenue Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include Sof tware Assurance (“SA”) and cloud services. Unearned revenue is generally invoiced annually at the beginning of each co ntract period f or multi-year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments f or other of f erings f or which we have been paid in advance and earn the revenue when we transf er control of the product or service. Ref er to Note 1 – Accounting Policies of the Notes to Financial Statements f or f urther discussion. The f ollowing table outlines the expected f uture recognition of unearned revenue as of June 30, 2020: (In millions) Three Months Ending September 30, 2020 December 31, 2020 March 31, 2021 June 30, 2021 Thereaf ter Total $ 13,884 10,950 7,476 3,690 3,180 $ 39,180 If our customers choose to license cloud -based versions of our products and services rather than licensing transaction- based products and services, the associated revenue will shif t f rom being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable. Share Repurchases For f iscal years 2020, 2019, and 2018, we repurchased 126 million shares, 150 million shares, and 99 million shares of our common stock f or $19.7 billion, $16.8 billion, and $8.6 billion, respectively, through our share repurchase programs. All repurchases were made using cash resources. Ref er to Note 16 – Stockholders’ Equity of the Notes to Financial Statements f or f urther discussion. Dividends Ref er to Note 16 – Stockholders’ Equity of the Notes to Financial Statements f or f urther discussion. 38 Off-Balance Sheet Arrangements We provide indemnif ications of varying scope and size to certain customers against claims of intellectual property inf ringement made by third parties arising f rom the use of our products and certain other matters. Additionally, we have agreed to cover damages resulting f rom breaches of certain security and privacy commitments in our cloud business. In evaluating estimated losses on these obligations, we consider f actors such as the degree of probability of an unf avorable outcome and our ability to make a reasonable estimate of the amount of loss. These obligations did not have a material impact in our consolidated f inancial statements during the periods presented. Contractual Obligations The f ollowing table summarizes the payments due by f iscal year f or our outstanding contractual obligations as of June 30, 2020: (In millions) Long-term debt: (a) Principal payments Interest payments Construction commitments (b) Operating leases, including imputed interest (c) Finance leases, including imputed interest (c) Transition tax (d) Purchase commitments (e) Other long-term liabilities (f) Total $ $ 2021 2022-2023 2024-2025 Thereafter Total 3,750 $ 10,716 $ 2,028 4,761 2,420 992 1,450 25,059 0 7,500 $ 45,441 25,265 3,293 0 0 4,409 2,929 9,611 2,676 4,531 6,343 272 369 356 32 40,460 $ 25,478 $ 23,142 $ 89,885 3,736 280 3,986 2,243 2,899 1,324 294 $ 67,407 34,322 5,041 13,744 15,522 15,223 27,024 682 $ 178,965 (a) Refer to Note 11 – Debt of the Notes to Financial Statements. (b) Refer to Note 7 – Property and Equipment of the Notes to Financial Statements. (c) Refer to Note 14 – Leases of the Notes to Financial Statements. (d) Refer to Note 12 – Income Taxes of the Notes to Financial Statements. (e) Amounts represent purchase commitments, including open purchase orders and take-or-pay contracts that are not presented as construction commitments above. (f ) We have excluded long-term tax contingencies, other tax liabilities, and deferred income taxes of $15.2 billion from the amounts presented as the timing of these obligations 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 inf rastructure, and existing and adva nced areas of technology, as well as continue making acquisitions that align with our business strategy. Additions to property and equipment will continue, including new f acilities, datacenters, and computer systems f or research and development, sales and marketing, support, and administrative staf f . We expect capital expenditures to increase in coming years to support growth in our cloud of f erings. We have operating and f inance leases f or datacenters, corporate of f ices, research and development f acilities, retail stores, and certain equipment. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially af f ect liquidity or the availability of capital resources. Liquidity As a result of the TCJA, we are required to pay a one-time transition tax on def erred f oreign income not previously subject to U.S. income tax. Under the TCJA, the transition tax is payable in interest -f ree installments over eight years, with 8% due in each of the f irst f ive years, 15% in year six, 20% in year seven, and 25% in year eight. We have paid 39 transition tax of $3.2 billion, which included $1.2 billion f or f iscal year 2020. The remaining transition tax of $15.2 billion is payable over the next six years with a f inal payment in f iscal year 2026. During f iscal year 2020, we also paid $3.7 billion related to the transf er of intangible properties that occurred in the f ourth quarter of f iscal year 2019. We expect existing cash, cash equivalents, short-term investments, cash f lows f rom operations, and access to capital markets to continue to be suf f icient to f und our operating activities and cash commitments f or investing and f inancing activities, such as dividends, share repurchases, debt maturities, material capital expenditures, and the transition tax rela ted to the TCJA, f or at least the next 12 mo nths and thereaf ter f or the f oreseeable f uture. Ref er to Note 1 – Accounting Policies of the Notes to Financial Statements f or f urther discussion. RECENT ACCOUNTING GUIDANCE APPLICATION OF CRITICAL ACCOUNTING POLICIES Our consolidated f inancial statements and accompanying notes are prepared in accordance with GAAP. Preparing consolidated f inancial statements requires management to make estimates and assumptions that af f ect the reported amounts of assets, liabilities, revenue, and expenses. These estimat es and assumptions are af f ected by management’s application of accounting policies, as well as uncertainty in the current economic environment due to the recent outbreak of COVID-19. Critical accounting policies f or us include revenue recognition, impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and inventories. Revenue Recognition Our contracts with customers of ten include promises to transf er multiple products and services to a customer. Determi ning whether products and services are considered distinct perf ormance obligations that should be accounted f or separately versus together may require signif icant judgment. When a cloud -based service includes both on-premises sof tware licenses and cloud services, judgment is required to determine whether the sof tware license is considered distinct and accounted f or separately, or not distinct and accounted f or together with the cloud service and recognized over time. Certain cloud services, primarily Of f ice 365, depend on a signif icant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted f or together as one perf ormance obligation. Revenue f rom Of f ice 365 is recognized ratably over the period in which the cloud services are provided. Judgment is required to determine the stand -alone selling price (“SSP”) f or each distinct perf ormance obligation. We use a single amount to estimate SSP f or items that are not sold separately, including on-premises licenses sold with SA or sof tware updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using inf ormation that may include market conditions and other observable inputs. We typically have more than one SSP f or individual products and services due to the stratif ication of those products and services by customers and circumstances. In these instances, we may use inf ormation such as the size of the custo mer and geographic region in determining the SSP. Due to the various benef its f rom and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benef its across our portf olio of customers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted f or as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional inf ormation becomes available. Changes to our estimated variable consideration were not material f or the periods presented. 40 Impairment of Investment Securities We review debt investments quarterly f or indicators of other-than-temporary impairment. This determination requires signif icant judgment. In making this judgment, we employ a systematic methodolo gy quarterly that considers available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of an investment exceeds its f air value, we evaluate, among other f actors, general market conditions, credit qual ity of debt instrument issuers, and the duration and extent to which the f air value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security bef ore recovery. In addition, we consider specif ic adverse conditions related to the f inancial health of and business outlook f or the investee, including industry and sector perf ormance, changes in technology, and operational and f inancing cash f low f actors. Once a decline in f air value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur f uture impairments. Equity investments without readily determinable f air values are written down to f air value if a qualitative assessment indicates that the investment is impaired and the f air value of the investment is less than carrying value. We perf orm a qualitative assessment on a quarterly basis. We are required to estimate the f air value of the investment to determine the amount of the impairment loss. Once an investment is determined to be impaired, an impairment charge is recorded in other income (expense), net. Goodwill We allocate goodwill to reporting units based on the reporting unit expected to benef it f rom the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative f air value allocation approach. Goodwill is tested f or impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 f or us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the f air value of a reporting unit below its carrying value. These events or circumstances could include a signif icant change in the business climate, legal f actors, operating perf ormance indicators, competition, or sale or disposition of a signif icant portion of a reporting unit. Application of the goodwill impairment test requires judgment, including the identif ication of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the f air value of each reporting unit. The f air value of each reporting unit is estimated primarily through the use of a discounted cash f low methodology. This analysis requires signif icant judgments, including estimation o f future cash f lows, which is dependent on internal f orecasts, estimation of the long -term rate of growth f or our business, estimation of the usef ul lif e over which cash f lows will occur, and determination of our weighted average cost of capital. The estimates used to calculate the f air value of a reporting unit change f rom year to year based on operating results, market conditions, and other f actors. Changes in these estimates and assumptions could materially af f ect the determination of f air value and goodwill impairment f or each reporting unit. Research and Development Costs Costs incurred internally in researching and developing a computer sof tware product are charged to expense until technological f easibility has been established f or the product. Once technological f easibility is established, sof tware costs are capitalized until the product is available f or general release to customers. Judgment is required in determining when technological f easibility of a product is established. We have determined that technological f easibility f or our sof tware products is reached af ter all high-risk development issues have been resolved through coding and testing. Generally, this occurs shortly bef ore the products are released to production. The amortization of these costs is included in cost of revenue over the estimated lif e of the products. 41 Legal and Other Contingencies The outcomes of legal proceedings and claims brought against us are subject to signif icant uncertainty. An estimated loss f rom a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. In determining whether a loss should be accrued we evaluate, among other f actors, the degree of probability of an unf avorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these f actors could materially impact our consolidated f inancial statements. Income Taxes The objectives of accounting f or income taxes are to recognize the amount of taxes payable or ref undable f or the current year, and def erred tax liabilities and assets f or the f uture tax consequences of events that have been recognized in an entity’s f inancial statements or tax returns. We recognize the tax benef it f rom an uncertain tax position only if it is mor e likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of t he position. The tax benef its recognized in the f inancial statements f rom such a position are measured based on the larges t benef it 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, classif ication of def erred income tax assets and liabilities, accounting f or interest and penalties associated with tax positions, and income tax disclosures. Judgment is required in assessing the f uture tax consequences of events that have been recognized in our consolidated f inancial statements or tax returns. Variations in the actual outcome of these f uture tax consequences could materially impact our consolidated f inancial statements. The TCJA signif icantly changes existing U.S. tax law and includes numerous provisions that af f ect our business. Ref er to Note 12 – Income Taxes of the Notes to Financial Statements f or f urther discussion. Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manuf acturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, f uture purchase commitments with our suppliers, and the estimated utility of our inventory. These reviews include analysis of demand f orecasts, product lif e 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. CHANGE IN ACCOUNTING ESTIMATE In July 2020, we completed an assessment of the usef ul lives of our server and network equipment and determined w e should increase the estimated usef ul lif e of server equipment f rom three years to f our years and increase the estimated usef ul lif e of network equipment f rom two years to f our years. This change in accounting estimate will be ef f ective beginning f iscal year 2021. Based on the carrying amount of server and network equipment included in “Property and equipment, net” as of June 30, 2020, it is estimated this change will increase our f iscal year 2021 operating income by $2.7 billion. 42 STATEMENT OF MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL STATEMENTS Management is responsible f or the preparation of the consolidated f inancial statements and related inf ormation that are presented in this report. The consolidated f inancial statements, which include amounts based on management’s estimates and judgments, have been prepared in conf ormity with accounting principles generally accepted in the United States of America. The Company designs and maintains accounting and internal control systems to provide reasonable assu rance at reasonable cost that assets are saf eguarded against loss f rom unauthorized use or disposition, and that the f inancial records are reliable f or preparing consolidated f inancial statements and maintaining accountability f or assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities, caref ul selection and trai ning of qualif ied personnel, and a program of internal audits. The Company engaged Deloitte & Touche LLP, an independent registered public accounting f irm, to audit and render an opinion on the consolidated f inancial statements and internal control over f inancial 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 pub lic accounting f irm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and f inancial reporting. Deloitte & Touche LLP and the internal auditors each have f ull and f ree access to the Audit Committee. Satya Nadella Chief Executive Of f icer Amy E. Hood Executive Vice President and Chief Financial Of f icer Frank H. Brod Corporate Vice President, Finance and Administration; Chief Accounting Of f icer 43 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK RISKS We are exposed to economic risk f rom f oreign exchange rates, interest rates, credit risk, and equity prices. We use derivatives instruments to manage these risks, however, they may still impact our consolidated f inancial statements. Foreign Currencies Certain f orecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our f oreign currenc y exposures daily to maximize the economic ef f ectiveness of our f oreign currency positions, including hedges. Principal currency exposures include the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Interest Rate Securities held in our f ixed-income portf olio are subject to different interest rate risks based on their maturities. We manage the average maturity of the f ixed-income portf olio to achieve economic returns that correlate to certain global f ixed -income indices. Credit Our f ixed-income portfolio is diversified and consists primarily of investment -grade securities. We manage credit exposures relative to broad-based indices and to f acilitate portf olio diversification. Equity Securities held in our equity investments portf olio are subject to price risk. SENSITIVITY ANALYSIS The f ollowing table sets f orth the potential loss in f uture earnings or f air values, including associated derivatives, result ing f rom hypothetical changes in relevant market rates or prices: (In millions) Risk Categories Foreign currency – Revenue Foreign currency – Investments Interest rate Credit Equity Hypothetical Change 10% decrease in f oreign exchange rates 10% decrease in f oreign exchange rates 100 basis point increase in U.S. treasury interest rates 100 basis point increase in credit spreads 10% decrease in equity market prices June 30, 2020 $ (4,142) (119) Impact Earnings Fair Value (3,951) (301) (239) Fair Value Fair Value Earnings 44 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INCOME STATEMENTS (In millions, except per share amounts) Year Ended June 30, Revenue: Product Service and other Total revenue Cost of revenue: Product Service and other Total cost of revenue Gross margin Research and development Sales and marketing General and administrative Operating income Other income, net Income bef ore income taxes Provision f or income taxes Net income Earnings per share: Basic Diluted Weighted average shares outstanding: Basic Diluted Ref er to accompanying notes. 2020 2019 2018 $ 68,041 $ 66,069 59,774 125,843 74,974 143,015 $ 64,497 45,863 110,360 16,017 30,061 46,078 96,937 19,269 19,598 5,111 52,959 77 53,036 8,755 $ 44,281 16,273 26,637 42,910 82,933 16,876 18,213 4,885 42,959 729 43,688 4,448 $ 39,240 15,420 22,933 38,353 72,007 14,726 17,469 4,754 35,058 1,416 36,474 19,903 $ 16,571 $ $ 5.82 5.76 $ $ 5.11 5.06 $ $ 2.15 2.13 7,610 7,683 7,673 7,753 7,700 7,794 45 2020 2018 $ 44,281 $ 39,240 $ 16,571 2019 (38) (426) 39 (173) (2,717) 3,990 2,405 (178) (318) (2,856) 3,526 1,914 $ 47,807 $ 41,154 $ 13,715 COMPREHENSIVE INCOME STATEMENTS (In millions) Year Ended June 30, Net income Other comprehensive income (loss), net of tax: Net change related to derivatives Net change related to investments Translation adjustments and other Other comprehensive income (loss) Comprehensive income Ref er to accompanying notes. 46 BALANCE SHEETS 2020 2019 (In millions) June 30, Assets Current assets: Cash and cash equivalents Short-term investments Total cash, cash equivalents, and short-term investments Accounts receivable, net of allowance f or doubtful accounts of $788 and $411 Inventories Other current assets Total current assets Property and equipment, net of accumulated depreciation of $43,197 and $35,330 Operating lease right-of -use assets Equity investments Goodwill Intangible assets, net Other long-term assets Total assets Liabilities and stockholders’ equity Current liabilities: Accounts payable Current portion of long-term debt Accrued compensation Short-term income taxes Short-term unearned revenue Other current liabilities Total current liabilities Long-term debt Long-term income taxes Long-term unearned revenue Def erred income taxes Operating lease liabilities Other long-term liabilities Total liabilities Commitments and contingencies Stockholders’ equity: Common stock and paid-in capital – shares authorized 24,000; outstanding 7,571 and 7,643 Retained earnings Accumulated other comprehensive income (loss) Total stockholders’ equity Total liabilities and stockholders’ equity Ref er to accompanying notes. 1,895 $ 13,576 $ 11,356 122,951 122,463 136,527 133,819 32,011 29,524 2,063 11,482 10,146 181,915 175,552 44,151 36,477 7,379 2,649 43,351 42,026 7,750 13,138 14,723 $ 301,311 $ 286,556 8,753 2,965 7,038 $ 12,530 $ 3,749 7,874 2,130 9,382 5,516 6,830 5,665 36,000 32,676 10,027 9,351 72,310 69,420 59,578 66,662 29,432 29,612 3,180 4,530 204 233 7,671 6,188 7,581 10,632 183,007 184,226 80,552 78,520 34,566 24,150 (340) 118,304 102,330 $ 301,311 $ 286,556 3,186 47 CASH FLOWS STATEMENTS (In millions) Year Ended June 30, Operations Net income Adjustments to reconcile net income to net cash f rom operations: Depreciation, amortization, and other Stock-based compensation expense Net recognized gains on investments and derivatives Def erred income taxes Changes in operating assets and liabilities: Accounts receivable Inventories Other current assets Other long-term assets Accounts payable Unearned revenue Income taxes Other current liabilities Other long-term liabilities Net cash f rom operations Financing Repayments of short-term debt, maturities of 90 days or less, net Proceeds f rom issuance of debt Cash premium on debt exchange Repayments of debt Common stock issued Common stock repurchased Common stock cash dividends paid Other, net Net cash used in f inancing Investing Additions to property and equipment Acquisition of companies, net of cash acquired, and purchases of intangible and other assets Purchases of investments Maturities of investments Sales of investments Other, net Net cash used in investing Ef f ect of foreign exchange rates on cash and cash equivalents Net change in cash and cash equivalents Cash and cash equivalents, beginning of period Cash and cash equivalents, end of period Ref er to accompanying notes. 48 2020 2019 2018 $ 44,281 $ 39,240 $ 16,571 12,796 11,682 10,261 5,289 4,652 3,940 (2,212) (5,143) (792) 11 (6,463) (219) 168 (3,862) (2,577) (2,812) (465) 597 (952) (2,330) (1,718) (285) (1,037) (1,834) 3,018 232 1,148 2,212 4,462 5,922 (3,631) 2,929 18,183 798 1,346 1,419 1,348 (20) 591 60,675 52,185 43,884 0 (7,324) 0 0 7,183 0 (3,417) 0 0 (5,518) (4,000) (10,060) 1,343 1,142 1,002 (10,721) (22,968) (19,543) (12,699) (15,137) (13,811) (971) (675) (33,590) (46,031) (36,887) (334) (15,441) (13,925) (11,632) (2,521) (2,388) (888) (77,190) (57,697) (137,380) 66,449 20,043 26,360 17,721 38,194 117,577 (98) 0 (1,241) (6,061) (12,223) (15,773) (201) (115) 50 (590) 4,283 2,220 11,356 11,946 7,663 $ 13,576 $ 11,356 $ 11,946 STOCKHOLDERS’ EQUITY STATEMENTS (In millions) Year Ended June 30, Common stock and paid-in capital Balance, beginning of period Common stock issued Common stock repurchased Stock-based compensation expense Other, net Balance, end of period Retained earnings Balance, beginning of period Net income Common stock cash dividends Common stock repurchased Cumulative ef f ect of accounting changes Balance, end of period Accumulated other comprehensive income (loss) Balance, beginning of period Other comprehensive income (loss) Cumulative ef f ect of accounting changes Balance, end of period Total stockholders’ equity 2020 2019 2018 (4,599) $ 78,520 $ 71,223 $ 69,315 1,343 6,829 1,002 (3,033) 5,289 4,652 3,940 (1) 80,552 78,520 71,223 (4,195) (1) 11 24,150 13,682 17,769 44,281 39,240 16,571 (12,917) (7,699) (42) 34,566 24,150 13,682 (14,103) (15,346) 677 (15,483) (18,382) 0 (340) (2,187) 627 (2,856) 3,526 1,914 42 0 3,186 (2,187) $ 118,304 $ 102,330 $ 82,718 (67) (340) Cash dividends declared per common share $ 2.04 $ 1.84 $ 1.68 Ref er to accompanying notes. 49 NOTES TO FINANCIAL STATEMENTS NOTE 1 — ACCOUNTING POLICIES Accounting Principles Our consolidated f inancial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). We have recast certain prior period amounts to conf orm to the current period presentation. The recast of these prior period amounts had no impact on our consolidated balance sheets, consolidated income statements, or net cash f rom or used in operating, f inancing, or investing on our consolidated cash f lows statements. Principles of Consolidation The consolidated f inancial statements include the accounts of Microsof t Corporation and its subsidiaries. Intercompany transactions and balances have been eliminated. Estimates and Assumptions Preparing f inancial statements requires management to make estimates and assumptions that af f ect the reported amounts of assets, liabilities, revenue, and expenses. Examples of estimates and assumptions include: f or revenue recognition, determining the nature and timing of satisf action of perf ormance obligations, and determining the standalone selling price (“SSP”) of perf ormance obligations, variable consideration, and other obligations such as product returns and ref unds; loss contingencies; product warranties; the f air value of and/or potential impairment of goodwill and intangible assets f or our reporting units; product lif e cycles; usef ul lives of our tangible and intangible assets; allowances f or doubtful accounts; t he market value of , and demand f or, our inventory; stock -based compensation f orf eiture rates; when technological f easibility is achieved f or our products; the potential outcome of uncertain tax positions that have been recognized in our consolidated f inancial statements or tax returns; and determining the timing and amount of impairment s f or investments. Actual results and outcomes may dif f er f rom management’s estimates and assumptions due to risks and uncertainties, including uncertainty in the current economic environment due to the recent outbreak of a novel strain of the coronavirus (“COVID- 19”). In July 2020, we completed an assessment of the usef ul lives of our server and network equipment and determined we should increase the estimated usef ul lif e of server equipment f rom three years to f our years and increase the estimated usef ul lif e of network equipment f rom two years to f our years. This change in accounting estimate will be ef f ective beginning f iscal year 2021. Foreign Currencies Assets and liabilities recorded in f oreign 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 f rom this process are recorded to other comprehensive income. Revenue Product Revenue and Service and Other Revenue Product revenue includes sales f rom operating systems; cross -device productivity applications; server applications; business solution applications; desktop and server management tools; sof tware development too ls; video games; and hardware such as PCs, tablets, gaming and entertainment consoles, other intelligent devices, and related accessories. 50 Service and other revenue includes sales f rom cloud -based solutions that provide customers with sof tware, services, platf orms, and content such as Of f ice 365, Azure, Dynamics 365, and Xbox Live; solution support; and consulting services. Service and other revenue also includes sales f rom online advertising and LinkedIn. Revenue Recognition Revenue is recognized upon transf er of control of promised products or services to customers in an amount that ref lects the consideration we expect to receive in exchange f or those products or services. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted f or as separate perf ormance obligations. Revenue is recognized net of allowances f or returns and any taxes collected f rom customers, which are subsequently remitted to governmental autho rities. Nature of Products and Services Licenses f or on-premises sof tware provide the customer with a right to use the sof tware as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which pr ovide customers with the same f unctionality and dif f er mainly in the duration over which the customer benef its f rom the sof tware. Revenue f rom distinct on-premises licenses is recognized upf ront at the point in time when the sof tware is made available to t he customer. In cases where we allocate revenue to sof tware updates, primarily because the updates are provided at no additional charge, revenue is recognized as the updates are provided, which is generally ratably over the estimated lif e of the related device or license. Certain volume licensing programs, including Enterprise Agreements, include on-premises licenses combined with Sof tware Assurance (“SA”). SA conveys rights to new sof tware and upgrades released over the contract period and provides support, tools, and training to help customers deploy and use products more ef f iciently. On-premises licenses are considered distinct perf ormance obligations when sold with SA. Revenue allocated to SA is generally recognized ratably over the contract period as customers simultaneously consume and receive benef its, given that SA comprises distinct perf ormance obligations that are satisf ied over time. Cloud services, which allow customers to use hosted sof tware over the contract period without taking possession of the sof tware, are provided on either a subscription or consumption basis. Revenue related to cloud services provided on a subscription basis is recognized ratably over the contract period. Revenue related to cloud services provided on a consumption basis, such as the amount of storage used in a period, is recognized based on the customer utilization of such resources. When cloud services require a signif icant level of integration and interdependency with sof tware and the individual components are not considered distinct, all revenue is recognized over the period in which the cloud services are provided. Revenue f rom search advertising is recognized when the advertisement appears in the search results or when the action necessary to earn the revenue has been completed. Revenue f rom consulting services is recognized as services are provided. Our hardware is generally highly dependent on, and interrelated with, the underlying operating system and cannot f unction without the operating system. In these cases, the hardware and sof tware license are accounted f or as a single perf ormance obligation and revenue is recognized at the point in time when ownership is transf erred to resellers or directly to end customers through retail stores and online marketplaces. Ref er to Note 19 – Segment Inf ormation and Geographic Data f or f urther inf ormation, including revenue by signif icant product and service of f ering. Significant Judgments Our contracts with customers of ten include promises to transf er multiple products and services to a customer. Determining whether products and services are considered distinct perf ormance obligations that should be 51 accounted f or separately versus together may require signif icant judgment. When a cloud -based service includes both on- premises sof tware licenses and cloud services, judgment is required to determine whether the sof tware license is considered distinct and accounted f or separately, or not distinct and accounted f or together with the cloud service and recognized over time. Certain cloud services, primarily Of f ice 365, depend on a signif icant level of integration, interdependency, and interrelation between the desktop applications and cloud services, and are accounted f or together as one perf ormance obligation. Revenue f rom Of f ice 365 is recognized ratably over the period in which the cloud services are provided. Judgment is required to determine the SSP f or each distinct perf ormance obligation. We use a single amount to estimate SSP f or items that are not sold separately, including o n-premises licenses sold with SA or sof tware updates provided at no additional charge. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated bas ed on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using inf ormation that may include market conditions and ot her observable inputs. We typically have more than one SSP f or individual products and services due to the stratif ication of those products and services by customers and circumstances. In these instances, we may use inf ormation such as the size of the cust omer and geographic region in determining the SSP. Due to the various benef its f rom and the nature of our SA program, judgment is required to assess the pattern of delivery, including the exercise pattern of certain benef its across our portf olio of custom ers. Our products are generally sold with a right of return, we may provide other credits or incentives, and in certain instances we estimate customer usage of our products and services, which are accounted f or as variable consideration when determining the amount of revenue to recognize. Returns and credits are estimated at contract inception and updated at the end of each reporting period if additional inf ormation becomes available. Changes to our estimated variable consideration were not material f or the periods presented. Contract Balances Timing of revenue recognition may dif fer f rom the timing of invoicing to customers. We record a receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For multi -year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record a receivable related to revenue recognized f or multi-year on-premises licenses as we have an unconditional right to invoice and receive payment in the f uture related to those licenses. As of June 30, 2020 and 2019, long-term accounts receivable, net of allowance f or doubtful accounts, was $2.7 billion and $2.2 billion, respectively, and is included in other long -term assets in our consolidated balance sheets. The allowance f or doubtf ul accounts ref lects 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 f or doubtf ul accounts was as f ollows: (In millions) Year Ended June 30, Balance, beginning of period Charged to costs and other Write-of f s Balance, end of period 52 2020 2018 2019 $ 434 $ 397 $ 361 560 153 134 (178) (116) (98) $ 816 $ 434 $ 397 Allowance f or doubtful accounts included in our consolidated balance sheets: (In millions) June 30, Accounts receivable, net of allowance f or doubtful accounts Other long-term assets Total 2020 2018 2019 $ 788 $ 411 $ 377 28 23 20 $ 816 $ 434 $ 397 Unearned revenue comprises mainly unearned revenue related to volume licensing programs, which may include SA and cloud services. Unearned revenue is generally invoiced annually at the beginning of each contract period f or multi -year agreements and recognized ratably over the coverage period. Unearned revenue also includes payments f or consulting services to be perf ormed in the f uture; LinkedIn subscriptions; Of fice 365 subscriptions; Xbox Live subscriptions; Windows 10 post-delivery support; Dynamics business solutions; Skype prepaid credits and subscriptions; and other of ferings for which we have been paid in advance and earn the revenue when we transf er control of the product or service. Ref er to Note 13 – Unearned Revenue f or f urther inf ormation, includ ing unearned revenue by segment and changes in unearned revenue during the period. Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition dif fers f rom the timing of invoicing, we have determined our contracts generally do not include a signif icant f inancing component. The primary purpose of our invoicing terms is to provide customers with simplif ied and predictable ways of purchasing our products and services, not to receive f inancing f rom our customers or to provide customers with f inancing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi -year on-premises licenses that are invoiced annually with revenue recognized upf ront. We record f inancing receivables when we of f er certain of our customers the option to acquire our sof tware products and services of f erings through a f inancing program in a limited number of countries. As of June 30, 2020 and 2019, our f inancing receivables, net were $5.2 billion and $4.3 billion, respectively, f or short-term and long-term f inancing receivables, which are included in other current assets and other long -term assets in our consolidated balance sheets. We record an allowance to cover expected losses based on troubled accounts, historical experience, and other currently available evidence. Assets Recognized from Costs to Obtain a Contract with a Customer We recognize an asset f or the incremental costs of obtaining a contract with a customer if we expect the benef it of those costs to be longer than one year. We have determined that certain sales incentive programs meet the requirements to be capitalized. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets in our consolidated balance sheets. We apply a practical expedient to expense costs as incurred f or costs to obtain a contract with a customer when the amortization period would have been one year or less . These costs include our internal sales f orce compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities. Cost of Revenue Cost of revenue includes: manuf acturing and distribution costs f or products sold and programs licensed; operating costs related to product support service centers and product distribution centers; costs incurred to include sof tware on PCs sold by original equipment manuf acturers (“OEM”), to d rive traf f ic to our websites, and to acquire online advertising space; costs incurred to support and maintain online 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 sof tware development costs. Capitalized sof tware development costs are amortized over the estimated lives of the products. 53 Product Warranty We provide f or the estimated costs of f ulf illing our obligations under hardware and sof tware warranties at the time the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected product f ailure rates, historical and projected repair costs, and knowledge of specif ic product f ailures (if any). The specif ic 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 f rom 90 days to three years. For sof tware warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated lif e of the sof tware. We regularly reevaluate ou r 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 benef its, 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 sof tware f or international markets, and the amortization of purchased sof tware code and services content. Such costs related to sof tware development are included in research and development expense until the point that technological f easibility is reached, which f or our sof tware products, is generally shortly bef ore the products are released to production. Once technological f easibility is reached, suc h 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 benef its, 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 $1.6 billion in f iscal years 2020, 2019, and 2018. Stock-Based Compensation Compensation cost f or stock awards, which include restricted stock units (“RSUs”) and perf ormance stock units (“PSUs”), is measured at the f air value on the grant date and recognized as expense, net of estimated f orf eitures, over the related service or perf ormance period. The f air value of stock awards is based on the quoted price of our common stock on the grant date less the present value of expected dividends not received during the vesting period. We measure the f air value of PSUs using a Monte Carlo valuation model. Compensation cost f or RSUs is recognized using the straight-line method and f or PSUs is recognized using the accelerated method. Compensation expense f or the employee stock purchase plan (“ESPP”) 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, and interest and penalties on uncertain tax positions. Certain income and expenses are not reported in tax returns and f inancial statements in the same year. The tax ef f ect of such temporary dif ferences is reported as def erred income taxes. Def erred tax assets are reported net of a valuation allowance when it is more likely than not that a tax benef it will not be realized. All def erred income taxes are classif ied as long-term in our consolidated balance sheets. 54 Financial Instruments Investments We consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to be cash equivalents. The f air 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 classif ied as short -term investments. Investments with maturities beyond one year may be classif ied as short -term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available f or current operations. Debt investments are classif ied as available-f or-sale and realized gains and losses are recorded using the specific identif ication method. Changes in f air value, excluding other-than-temporary impairments, are recorded in other comprehensive income. Debt investments are impaired when a decline in f air value is judged to be other-than-temporary . Fair value is calculated based on publicly available market inf ormation 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 f air value, we evaluate, among other f actors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the f air value is less than cost. We also evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the security bef ore recovery. In addition, we consider specif ic adverse conditions related to the f inancial health of , and business outlook, f or the investee, including industry and sector perf ormance, changes in technology , and operational and f inancing cash f low f actors. Once a decline in f air value is determined to be other -than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established. Equity investments with readily determinable f air values are measured at f air value. Equity investments without readily determinable f air values are measured using the equity method or measured at cost with adjustments f or observable changes in price or impairments (ref erred to as the measurement alternative). We perf orm a qualitative assessment on a quarterly basis and recognize an impairment if there are suf f icient indicators that the f air value of the investment is less than carrying value. Changes in value are recorded in other income (expense), net. Derivatives Derivative instruments are recognized as either assets o r liabilities and measured at f air value. The accounting f or changes in the f air value of a derivative depends on the intended use of the derivative and the resulting designation. For derivative instruments designated as f air value hedges, gains and losses are recognized in other income (expense), net with of f setting gains and losses on the hedged items. Gains and losses representing hedge components excluded from the assessment of ef f ectiveness are recognized in other income (expense), net. For derivative instruments designated as cash f low hedges, gains and losses are initially reported as a component of other comprehensive income and subsequently recognized in earnings with the corresponding hedged item. Gains and losses representing hedge components excluded f rom the assessment of ef fectiveness are recognized in earnings. For derivative instruments that are not designated as hedges, gains and losses f rom changes in f air values are primarily recognized in other income (expense), net. Fair Value Measurements We account f or certain assets and liabilities at f air value. The hierarchy below lists three levels of f air value based on th e extent to which inputs used in measuring f air value are observable in the market. We categorize each of our f air 55 value measurements in one of these three levels based on the lowest level input that is signif icant to the f air value measurement in its entirety. These levels are: • • • Level 1 – inputs are based upon unadjusted quoted prices f or identical instruments in active markets. Our Level 1 investments include U.S. government securities, common and pref erred stock, and mutual f unds. Our Level 1 derivative assets and liabilities include those actively traded on exchanges. Level 2 – inputs are based upon quoted prices f or similar instruments in active markets, quoted prices f or identical or similar instruments in markets that are not active, and model -based valuation techniques (e.g. the Black-Scholes model) f or which all signif icant inputs are observable in the market or can be corroborated by observable market data f or substantially the f ull term of the assets or liabilities. Where applicable, these models project f uture cash f lows and discount the f uture amounts to a present value using market -based observable inputs including interest rate curves, credit spreads, f oreign exchange rates, and f orward and spot prices f or currencies. Our Level 2 investments include commercial paper, certif icates of deposit, U.S. agency securities, f oreign government bonds, mortgage- and asset-backed securities, corporate notes and bonds, and municipal securities. Our Level 2 derivative assets and liabilities primarily include certain over-the-counter option and swap contracts. Level 3 – inputs are generally unobservable and typically ref lect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The f air values are theref ore determined using model-based techniques, including option pricing models and discounted cash f low models. Our Level 3 assets and liabilities include investments in corporate notes and bonds, municipal securities, and goodwill and intangible assets, when they are recorded at f air value due to an impairment charge. Unobservable inputs used in the models are signif icant to the f air values of the assets and liabilities. We measure equity investments without readily determinable f air values on a nonrecurring basis. The f air values of thes e investments are determined based on valuation techniques using the best inf ormation available, and may include quoted market prices, market comparables, and discounted cash f low projections. Our other current f inancial assets and current f inancial liabilities have f air values that approximate their carrying values. Inventories Inventories are stated at average cost, subject to the lower of cost or net realizable value. Cost includes materials, labor, and manuf acturing overhead related to the purchase and production of inventories. Net realizable value is the estimated selling price less estimated costs of completion, disposal, and transportation. We regularly review inventory quantities on hand, f uture purchase commitments with our suppliers, and the es timated 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 less accumulated depreciation, and depreciated using the straight -line method over the shorter of the estimated usef ul lif e of the asset or the lease term. The estimated usef ul lives of our property and equipment are generally as f ollows: computer sof tware developed or acquired f or internal use, three to seven years; computer equipment, two to three years; buildings and improvements, f ive to 15 years; leasehold improvements, three to 20 years; and f urniture and equipment, one to 10 years. Land is not depreciated. Leases We determine if an arrangement is a lease at inception. Operating leases are included in operating lease right -of -use (“ROU”) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. Finance leases are included in property and equipment, other current liabilities, and other long -term liabilities in our consolidated balance sheets. 56 ROU assets represent our right to use an underlying asset f or the lease term and lease liabilities represent our obliga tion to make lease payments arising f rom the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we generally use our incremental borrowing rate based on the estimated rate of interest f or collateralized borrowing over a similar term of the lease payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense f or lease payments is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are generally accounted f or separately. For certain equipment leases, such as vehicles, we account f or the lease and non-lease components as a single lease component. Additionally, f or certain equipment leases, we apply a portf olio approach to ef fectively account f or the operating lease ROU assets and liabilities. Goodwill Goodwill is tested f or impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 f or us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the f air value of a reporting unit below its carrying value. Intangible Assets Our intangible assets are subject to amortization and are amortized using the straight -line method over their estimated period of benef it, ranging f rom one to 20 years. We evaluate the recoverability of intangible assets periodically by taking into account events or circumstances that may warrant revised estimates of usef ul lives or that indicate the asset may be impaired. Recent Accounting Guidance Recently Adopted Accounting Guidance Financial Instruments – Targeted Improvements to Accounting for Hedging Activities In August 2017, the Financial Accounting Standards Board (“FASB”) issued new guidance related to accounting f or hedging activities. This guidance expands strategies that qualif y f or hedge accounting, changes how many hedging relationships are presented in the f inancial statements, and simplif ies the application of hedge accounting in certain situations. We adopted the standard ef f ective July 1, 2019. As we did not hold derivative instruments requiring an adjustment upon adoption, there was no impact in our consolidated f inancial statements. Adoption of the standard enhanced the presentation of the ef f ects of our hedging instruments and the hedged items in o ur consolidated f inancial statements to increase the understandability of the results of our hedging strategies. Recent Accounting Guidance Not Yet Adopted Financial Instruments – Credit Losses In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology under current GAAP with a methodology that ref lects expected credit losses and requires consideration of a broader range of reasonable and supportable inf ormation to inf orm credit loss estimates. We will be required to use a f orward-looking expected credit loss model f or accounts receivable, loans, and other f inancial instruments. Credit losses relating to available -f or-sale debt securities will also be recorded through an allowance f or credit losses rather than as a reduction in the amortized cost basis of the securities. The standard will be adopted upon the ef f ective date f or us beginning July 1, 2020. Adoption of the standard will be applied using a modif ied retrospective approach through 57 a cumulative-ef f ect adjustment to retained earnings as of the ef f ective date to align our credit loss methodology with the new standard. We have evaluated the impact of this standard in our consolidated financial statements, including accounting policies, processes, and systems. We continue to monitor economic implications of the COVID -19 pandemic. Based on current market conditions, adoption of the standard will not have a material impact on our consolidated f inancial statements. Accounting for Income Taxes In December 2019, the FASB issued a new standard to simplif y the accounting f or income taxes. The guidance eliminates certain exceptions related to the approach f or intraperiod tax allocation, the methodology f or calculating income taxes in an interim period, and the recognition of def erred tax liabilities f or outside basis differences related to changes in ownership of equity method investments and f oreign subsidiaries. The guidance also simplif ies aspects of accounting f or f ranchise taxes and enacted changes in tax laws or rates, and clarif ies the accounting f or transactions that result in a step -up in the tax basis of goodwill. The standard will be ef f ective f or us beginning July 1, 2021, with early adoption permitted. We are currently evaluating the impact of this standard in our consolidated f inancial statements, including accounting policies, processes, and systems. NOTE 2 — EARNINGS PER SHARE Basic earnings per share (“EPS”) is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted EPS is computed based on the weighted average number of shares of common stock plus the ef f ect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards. The components of basic and diluted EPS were as f ollows: (In millions, except earnings per share) Year Ended June 30, Net income available f or common shareholders (A) Weighted average outstanding shares of common stock (B) Dilutive ef f ect of stock-based awards Common stock and common stock equivalents (C) Earnings Per Share Basic (A/B) Diluted (A/C) 2020 2018 $ 44,281 $ 39,240 $ 16,571 2019 7,610 73 7,683 7,673 80 7,753 7,700 94 7,794 $ $ 5.82 $ 5.76 $ 5.11 $ 5.06 $ 2.15 2.13 Anti-dilutive stock-based awards excluded f rom the calculations of diluted EPS were immaterial during the periods presented. The components of other income (expense), net were as f ollows: NOTE 3 — OTHER INCOME (EXPENSE), NET (In millions) Year Ended June 30, Interest and dividends income Interest expense Net recognized gains on investments Net gains (losses) on derivatives Net losses on f oreign currency remeasurements Other, net Total 58 2019 2020 (2,686) 2018 $ 2,680 $ 2,762 $ 2,214 (2,733) 648 2,399 (187) 144 (218) (82) (57) (59) 729 $ 1,416 (2,591) 32 187 (191) (40) 77 $ $ Net Recognized Gains (Losses) on Investments Net recognized gains (losses) on debt investments were as f ollows: (In millions) Year Ended June 30, Realized gains f rom sales of available-f or-sale securities Realized losses f rom sales of available-f or-sale securities Other-than-temporary impairments of investments Total Net recognized gains (losses) on equity investments were as f ollows: (In millions) Year Ended June 30, Net realized gains on investments sold Net unrealized gains on investments still held Impairments of investments Total 2020 $ 50 (37) (17) (4) $ 2019 $ 12 (93) (16) $ (97) $ 2018 27 (987) (6) $ (966) 2020 $ 83 69 (116) 36 $ 2019 $ 276 479 (10) $ 745 2018 $ 3,406 0 (41) $ 3,365 59 Investment Components The components of investments were as f ollows: NOTE 4 — INVESTMENTS Fair Value Level Cost Basis Unrealized Gains Unrealized Losses Recorded Basis Cash and Cash Equivalents Short-term Investments Equity Investments (In millions) June 30, 2020 Changes in Fair Value Recorded in Other Comprehensive Income 4,687 $ 2,898 1 Level 2 $ Level 2 0 Level 1 92,067 6,495 2 Level 2 6 Level 2 2,439 6,982 $ 3,070 $ 4,688 $ 1,618 $ 0 $ 0 1,252 2,898 1,646 (1) 98,561 3,168 95,393 1,992 0 6,984 (3) 2,441 6,985 449 1 Level 2 Level 2 Level 3 Level 2 Level 3 41 4,865 327 8,500 0 58 57 313 0 91 $ 122,900 $ 6,929 (6) (17) 0 (4) 0 4,900 8,810 58 366 91 0 0 0 0 0 4,900 8,810 58 366 91 $ (31) $ 129,798 $ 6,882 $ 122,916 $ 0 0 0 0 0 0 0 0 0 0 0 Level 1 Other $ $ 414 0 $ 784 $ 1,198 $ 2,551 0 0 2,551 0 $ 2,965 3,749 $ 784 $ 0 0 $ 5,910 $ 5,910 $ 0 35 0 $ 139,492 $ 13,576 $ 122,951 $ 2,965 35 $ Commercial paper Certif icates of deposit U.S. government securities U.S. agency securities Foreign government bonds Mortgage- and asset-backed securities Corporate notes and bonds Corporate notes and bonds Municipal securities Municipal securities Total debt investments Changes in Fair Value Recorded in Net Income Equity investments Equity investments Total equity investments Cash Derivatives, net (a) Total 60 Fair Value Level Cost Basis Unrealized Gains Unrealized Losses Recorded Basis Cash and Cash Equivalents Short-term Investments Equity Investments (In millions) June 30, 2019 Changes in Fair Value Recorded in Other Comprehensive Income Commercial paper Certif icates of deposit U.S. government securities U.S. agency securities Foreign government bonds Mortgage- and asset-backed securities Corporate notes and bonds Corporate notes and bonds Municipal securities Municipal securities Total debt investments Changes in Fair Value Recorded in Net Income Equity investments Equity investments Total equity investments Cash Derivatives, net (a) Total 2,211 $ 2,018 0 $ Level 2 $ Level 2 0 Level 1 104,925 1,854 0 Level 2 4 Level 2 988 6,350 (104) 106,675 988 2,211 $ 1,773 $ 2,018 1,430 438 $ 588 769 105,906 290 698 3,840 6,346 2,506 0 $ 0 0 (8) Level 2 Level 2 Level 3 Level 2 Level 3 3,554 7,437 15 242 7 3,561 7,541 15 290 7 $ 127,747 $ 2,027 $ (122) $ 129,652 $ 7,176 $ 122,476 $ 3,561 7,541 15 290 7 (3) (7) 0 0 0 10 111 0 48 0 0 0 0 0 0 Level 1 Other $ $ 409 $ 973 $ 0 2,085 3,058 $ 409 $ 3,771 $ 3,771 $ 0 0 $ 0 0 $ 0 $ (13) $ 136,468 $ 11,356 $ 122,463 $ (13) $ 0 0 0 0 0 0 0 0 0 0 0 564 2,085 2,649 0 0 2,649 (a) Refer to Note 5 – Derivatives for further information on the fair value of our derivative instruments. Equity investments presented as “Other” in the tables above include investments without readily determinable f air values measured using the equity method or measured at cost with adjustments f or observable changes in price or impairments, and investments measured at f air value using net asset value as a practical expedient which are not categorized in the f air value hierarchy. As of June 30, 2020 and 2019, equity investments without readily determinable f air values measured at cost with adjustments f or observable changes in price or impairments were $1.4 billion and $1.2 billion, respectively. 61 Unrealized Losses on Debt Investments Debt investments with continuous unrealized losses f or less than 12 months and 12 months or greater and their related f air values were as f ollows: (In millions) June 30, 2020 U.S. government and agency securities Foreign government bonds Mortgage- and asset-backed securities Corporate notes and bonds Municipal securities Total (In millions) June 30, 2019 U.S. government and agency securities Foreign government bonds Mortgage- and asset-backed securities Corporate notes and bonds Total Less than 12 Months Unrealized Losses Fair Value 12 Months or Greater Unrealized Losses Fair Value Total Fair Value Total Unrealized Losses $ 2,323 500 1,014 649 66 $ 4,552 $ $ (1) (3) (6) (17) (4) (31) $ $ 0 0 0 0 0 0 $ $ 0 0 0 0 0 0 $ 2,323 $ 500 1,014 649 66 $ 4,552 $ (1) (3) (6) (17) (4) (31) Less than 12 Months Unrealized Losses Fair Value 12 Months or Greater Unrealized Losses Fair Value Total Fair Value Total Unrealized Losses $ 1,491 $ 25 664 498 $ 2,678 $ (1) $ 39,158 $ 0 (1) (3) (5) $ 39,989 $ 77 378 376 (103) $ 40,649 $ (8) (2) (4) 102 1,042 874 (117) $ 42,667 $ (104) (8) (3) (7) (122) Unrealized losses f rom f ixed-income securities are primarily attributable to changes in interest rates. Management does not believe any remaining unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence. Debt Investment Maturities (In millions) June 30, 2020 Due in one year or less Due af ter one year through f ive years Due af ter f ive years through 10 years Due af ter 10 years Total Cost Basis Estimated Fair Value $ 36,169 51,465 32,299 2,967 $ 122,900 $ 36,276 54,700 35,674 3,148 $ 129,798 NOTE 5 — DERIVATIVES We use derivative instruments to manage risks related to f oreign currencies, interest rates, equity prices, and credit; to enhance investment returns; and to f acilitate portf olio diversification. Our objectives f or holding derivatives include reduc ing, eliminating, and ef f iciently managing the economic impact of these exposures as ef f ectively as possible. Our derivative programs include strategies that both qualif y and do not qualif y f or hedge accounting treatment. Foreign Currencies Certain f orecasted transactions, assets, and liabilities are exposed to foreign currency risk. We monitor our f oreign currency exposures daily to maximize the economic ef f ectiveness of our f oreign currency hedge positions. 62 Foreign currency risks related to certain non-U.S. dollar-denominated investments are hedged using f oreign exchange f orward contracts that are designated as f air value hedging instruments. Foreign currency risks related to certain Euro - denominated debt are hedged using f oreign exchange f orward contracts that are designated as cash f low hedging instruments. In the past, option and f orward contracts were used to hedge a portion of f orecasted international revenue and were designated as cash f low hedging instruments. Principal currencies hedged included the Euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Certain options and f orwards not designated as hedging instruments are also used to manage the variability in f oreign exchange rates on certain balance sheet amounts and to manage other f oreign currency exposures. Interest Rate Interest rate risks related to certain f ixed -rate debt are hedged using interest rate swaps that are designated as f air value hedging instruments to ef f ectively convert the f ixed interest rates to f loating interest rates. Securities held in our f ixed-income portf olio are subject to different interest rate risks based on their maturities. We manage the average maturity of our f ixed-income portf olio to achieve economic returns that correlate to certain broad -based f ixed- income indices using exchange-traded option and f utures contracts and over-the-counter swap and option contracts. These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below. Equity Securities held in our equity investments portf olio are subject to market price risk. At times, we may hold options, f utures, and swap contracts. These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below. Credit Our f ixed-income portf olio is diversif ied and consists primarily of investment -grade securities. We use credit def ault swap contracts to manage credit exposures relative to broad -based indices and to f acilitate portf olio diversif ication. These contracts are not designated as hedging instruments and are included in “Other contracts” in the tables below. Credit-Risk-Related Contingent Features Certain of our counterparty agreements f or derivative instruments contain provisions that require our issued and outstan ding 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 f ail 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, 2020, 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. 63 The f ollowing table presents the notional amounts of our outstanding derivative instruments measured in U.S. dollar equivalents: (In millions) Designated as Hedging Instruments Foreign exchange contracts purchased Foreign exchange contracts sold Interest rate contracts purchased Not Designated as Hedging Instruments Foreign exchange contracts purchased Foreign exchange contracts sold Other contracts purchased Other contracts sold Fair Values of Derivative Instruments The f ollowing table presents our derivative instruments: (In millions) Designated as Hedging Instruments Foreign exchange contracts Interest rate contracts Not Designated as Hedging Instruments Foreign exchange contracts Other contracts Gross amounts of derivatives Gross amounts of derivatives of fset in the balance sheet Cash collateral received Net amounts of derivatives Reported as Short-term investments Other current assets Other long-term assets Other current liabilities Other long-term liabilities Total June 30, 2020 June 30, 2019 $ 635 6,754 1,295 $ 0 6,034 0 11,896 15,595 1,844 757 14,889 15,614 2,007 456 Derivative Assets Derivative Liabilities June 30, 2020 Derivative Assets Derivative Liabilities June 30, 2019 $ 44 93 $ (54) $ 0 0 0 $ (93) 0 245 18 400 (154) 0 $ 246 (334) (11) (399) 158 (154) 204 46 250 (113) 0 $ (395) $ 137 35 $ 199 12 0 0 $ 246 $ 0 0 0 (334) (61) (13) $ 146 4 0 0 $ (395) $ 137 (172) (7) (272) 114 (78) $ (236) $ 0 0 0 (221) (15) $ (236) Gross derivative assets and liabilities subject to legally enf orceable master netting agreements f or which we have elected to of fset were $399 million and $399 million, respectively, as of June 30, 2020, and $247 million and $272 million, respectively, as of June 30, 2019. 64  The f ollowing table presents the f air value of our derivatives instruments on a gross basis: (In millions) June 30, 2020 Derivative assets Derivative liabilities June 30, 2019 Derivative assets Derivative liabilities Level 1 Level 2 Level 3 Total $ 1 $ 398 (399) 0 $ 1 $ 400 (399) 0 0 0 247 (272) 3 0 250 (272) Gains (losses) on derivative instruments recognized in our consolidated income statements were as f ollows: (In millions) Year Ended June 30, Designated as Fair Value Hedging Instruments Foreign exchange contracts Derivatives Hedged items Excluded f rom ef f ectiveness assessment Interest rate contracts Derivatives Hedged items Equity contracts Derivatives Hedged items Excluded f rom ef f ectiveness assessment Designated as Cash Flow Hedging Instruments Foreign exchange contracts Amount reclassif ied f rom accumulated other comprehensive income Excluded f rom ef f ectiveness assessment Not Designated as Hedging Instruments Foreign exchange contracts Other contracts 2020 Other Income (Expense), Net Revenue 2019 Other Income (Expense), Net 2018 Other Income (Expense), Net Revenue Revenue $ 0 $ 0 0 1 3 139 $ 0 0 0 0 0 0 0 0 $ (130) $ 130 168 0 0 0 0 0 0 0 0 0 0 0 0 0 $ (78) 78 103 0 0 (324) 324 80 341 (64) 0 0 185 (255) 0 0 93 (93) 0 0 0 0 0 (123) 50 0 0 (97) 38 0 0 (33) (104) 0 0 0 0 0 0 0 0 0 Gains (losses), net of tax, on derivative instruments recognized in our consolidated comprehensive income statements were as f ollows: (In millions) Year Ended June 30, Designated as Cash Flow Hedging Instruments Foreign exchange contracts Included in ef f ectiveness assessment 2020 2019 2018 $ (38) $ 159 $ 219 65 The components of inventories were as f ollows: NOTE 6 — INVENTORIES (In millions) June 30, Raw materials Work in process Finished goods Total The components of property and equipment were as f ollows: NOTE 7 — PROPERTY AND EQUIPMENT $ 2020 2019 700 $ 399 53 83 1,112 1,611 $ 1,895 $ 2,063 (In millions) June 30, Land Buildings and improvements Leasehold improvements Computer equipment and sof tware Furniture and equipment Total, at cost Accumulated depreciation Total, net 2020 2019 $ 1,823 $ 1,540 26,288 5,316 33,823 4,840 71,807 (35,330) $ 44,151 $ 36,477 33,995 5,487 41,261 4,782 87,348 (43,197) During f iscal years 2020, 2019, and 2018, depreciation expense was $10.7 billion, $9.7 billion, and $7.7 billion, respectively. We have committed $5.0 billion f or the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2020. During f iscal year 2020, we recorded an impairment charge of $186 million to Property and Equipment, primarily to leasehold improvements, due to the closing of our Microsof t Store physical locations. GitHub, Inc. NOTE 8 — BUSINESS COMBINATIONS On October 25, 2018, we acquired GitHub, Inc. (“GitHub”), a sof tware development platf orm, in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The acquisition is expected to empower developers to achieve more at every stage of the development lif ecycle, accelerate enterprise use of GitHub, and bring Microsof t’s developer tools and services to new audiences. The f inancial results of GitHub have been included in our consolidated f inancial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment. The allocation of the purchase price to goodwill was completed as of June 30, 2019. The major classes of assets and liabilities to which we allocated the purchase price were as f ollows: (In millions) Cash, cash equivalents, and short-term investments Goodwill Intangible assets Other assets Other liabilities Total 66 $ 234 5,497 1,267 143 (217) $ 6,924 The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies f rom f uture growth and is not expected to be deductible f or tax purposes. We assigned the goodwill to our Intelligent Cloud segment. Following are the details of the purchase price allocated to the intangible assets acquired: (In millions) Customer-related Technology-based Marketing-related Contract-based Total Amount Weighted Average Life $ 8 years 648 447 5 years 170 10 years 2 years 7 years 2 $ 1,267 Transactions recognized separately f rom the purchase price allocation were approximately $600 million, primarily related to equity awards recognized as expense over the related service period. Other During f iscal year 2020, we completed 15 acquisitions f or $2.4 billion, substantially all of which were paid in cash. These entities have been included in our consolidated results of operations since their respective acquisition dates. The ef f ects o f these business combinations, individually and in aggregate, were not material to our consolidated results of operations. Changes in the carrying amount of goodwill were as f ollows: NOTE 9 — GOODWILL June 30, (In millions) 2018 Productivity and Business Processes $ 23,823 5,703 Intelligent Cloud 6,157 More Personal Computing $ 35,683 Total June 30, Acquisitions Other $ 514 $ (60) $ 24,277 11,351 43 (a) 6,398 (48) $ 6,408 $ (65) $ 42,026 5,605 (a) 289 2019 Acquisitions $ June 30, Other 2020 (94 ) $ 24,190 12,697 (5 ) 6,464 (30 ) $ 1,454 $ (129 ) $ 43,351 7 $ 1,351 96 (a) Includes goodwill of $5.5 billion related to GitHub. See Note 8 – Business Combinations for further information. The measurement periods f or the valuation of assets acquired and liabilities assumed end as soon as inf ormation on the f acts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined. Any change in the goodwill amounts resulting f rom f oreign currency translations and purchase accounting adjustments are presented as “Other” in the table above. Also included in “Other” are business dispositions and transf ers between segments due to reorganizations, as applicable. Goodwill Impairment We test goodwill f or impairment annually on May 1 at the reporting unit level, primarily using a discounted cash f low methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use o f a discounted cash f low approach is the most reliable indicator of the f air values of the businesses. 67 No instances of impairment were identif ied in our May 1, 2020, May 1, 2019, or May 1, 2018 tests. As of June 30, 2020 and 2019, accumulated goodwill impairment was $11.3 billion. The components of intangible assets, all of which are f inite-lived, were as f ollows: NOTE 10 — INTANGIBLE ASSETS (In millions) June 30, Technology-based Customer-related Marketing-related Contract-based Total Gross Carrying Amount Accumulated Amortization $ 8,160 $ 4,967 4,158 474 (6,381) $ (2,320) (1,588) (432) Gross Carrying Amount Net Carrying Amount 2020 1,779 $ 7,691 4,709 2,647 4,165 2,570 574 42 $ 17,759 $ (10,721) $ 7,038 $ 17,139 (a) Accumulated Amortization $ (5,771) (1,785) (1,327) (506) $ (9,389) Net Carrying Amount 2019 $ 1,920 2,924 2,838 68 $ 7,750 (a) Includes intangible assets of $1.3 billion related to GitHub. See Note 8 – Business Combinations for further information. No material impairments of intangible assets were identif ied during f iscal years 2020, 2019, or 2018. We estimate that we have no signif icant residual value related to our intangible assets. The components of intangible assets acquired during the periods presented were as f ollows: (In millions) Year Ended June 30, Technology-based Customer-related Marketing-related Contract-based Total Amount 2020 $ 531 303 2 0 $ 836 Weighted Average Life Amount 2019 814 6 years $ 710 5 years 177 2 years 0 years 7 5 years $ 1,708 Weighted Average Life 5 years 8 years 10 years 3 years 7 years Intangible assets amortization expense was $1.6 billion, $1.9 billion, and $2.2 billion f or f iscal years 2020, 2019, and 2018, respectively. The f ollowing table outlines the estimated f uture amortization expense related to intangible assets held as of Jun e 30, 2020: (In millions) Year Ending June 30, 2021 2022 2023 2024 2025 Thereaf ter Total 68 $ 1,483 1,399 1,219 851 447 1,639 $ 7,038 The components of debt were as f ollows: (In millions, issuance by calendar year) 2009 issuance of $3.8 billion (a) 2010 issuance of $4.8 billion (a) 2011 issuance of $2.3 billion (a) 2012 issuance of $2.3 billion 2013 issuance of $5.2 billion (a) 2013 issuance of €4.1 billion 2014 issuance 2015 issuance of $23.8 billion (a) 2016 issuance of $19.8 billion (a) 2017 issuance of $17.0 billion (a) 2020 issuance of $10.0 billion (a) Total f ace value Unamortized discount and issuance costs Hedge f air value adjustments (b) Premium on debt exchange (a) Total debt Current portion of long-term debt Long-term debt NOTE 11 — DEBT Maturities (calendar year) 2039 Stated Interest Rate 5.20% Effective Interest Rate 5.24% $ 2020–2040 3.00%–4.50% 3.14%–4.57% 2021–2041 4.00%–5.30% 4.08%–5.36% 2022–2042 2.13%–3.50% 2.24%–3.57% 2023–2043 2.38%–4.88% 2.47%–4.92% 2021–2033 2.13%–3.13% 2.23%–3.22% 2020–2055 2.00%–4.75% 2.09%–4.78% 2021–2056 1.55%–3.95% 1.64%–4.03% 2022–2057 2.40%–4.50% 2.52%–4.53% 2050–2060 2.53%–2.68% 2.53%–2.68% June 30, 2020 559 $ 1,571 1,270 1,650 2,919 4,549 0 15,549 16,955 12,385 10,000 67,407 June 30, 2019 750 2,000 1,500 1,650 3,500 4,613 18 22,000 19,750 17,000 0 72,781 (603) 0 0 72,178 (5,516) $ 59,578 $ 66,662 (554) 93 (3,619) 63,327 (3,749) (a) In June 2020, we exchanged a portion of our existing debt at premium for cash and new debt with longer maturities. The premium will be amortized over the term of the new debt. (b) Refer to Note 5 – Derivatives for further information on the interest rate swaps related to fixed-rate debt. As of June 30, 2020 and 2019, the estimated f air value of long -term debt, including the current portion, was $77.1 billion and $78.9 billion, respectively. The estimated f air values are based on Level 2 inputs. Debt in the table above is comprised of senior unsecured obligations and ranks equally with our other outstanding obligations. Interest is paid semi-annually, except f or the Euro-denominated debt, which is paid annually. The f ollowing table outlines maturities of our long -term debt, including the current portion, as of June 30, 2020: (In millions) Year Ending June 30, 2021 2022 2023 2024 2025 Thereaf ter Total $ 3,750 7,966 2,750 5,250 2,250 45,441 $ 67,407 69 Tax Cuts and Jobs Act NOTE 12 — INCOME TAXES On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was enacted into law, which signif icantly changed existing U.S. tax law and included numerous provisions that af f ect our business. We recorded a provisional net charge of $13.7 billion related to the enactment of the TCJA in f iscal year 2018, and adjusted the provisional net charge by recording additional tax expense of $157 million in f iscal year 2019 pursuant to Securities and Exchange Commission Staf f Accounting Bulletin No. 118. In f iscal year 2019, in response to the TCJA and recently issued regulations, we transf erred certain intangible properties held by our f oreign subsidiaries to the U.S. and Ireland. The transf ers of intangible properties resulted in a $2.6 billion net income tax benef it recorded in the f ourth quarter of f iscal year 2019, as the value of f uture tax deductions exceeded the current tax liability f rom f oreign jurisdictions and U.S. global intangible low-taxed income (“GILTI”) tax. Provision for Income Taxes The components of the provision f or income taxes were as f ollows: 2020 2019 2018 $ 3,537 $ 4,718 $ 19,764 934 662 4,348 5,531 $ 8,744 $ 10,911 $ 25,046 763 4,444 $ 58 $ (5,647) $ (6) (41) 11 $ (6,463) $ (4,292) (458) (393) (5,143) $ $ 8,755 $ 4,448 $ 19,903 (1,010) 194 2020 2019 2018 $ 24,116 $ 15,799 $ 11,527 28,920 24,947 27,889 $ 53,036 $ 43,688 $ 36,474 (In millions) Year Ended June 30, Current Taxes U.S. f ederal U.S. state and local Foreign Current taxes Deferred Taxes U.S. f ederal U.S. state and local Foreign Def erred taxes Provision f or income taxes U.S. and f oreign components of income bef ore income taxes were as f ollows: (In millions) Year Ended June 30, U.S. Foreign Income bef ore income taxes 70 Effective Tax Rate The items accounting f or the dif f erence between income taxes computed at the U.S. f ederal statutory rate and our ef f ective rate were as f ollows: Year Ended June 30, Federal statutory rate Ef f ect of: Foreign earnings taxed at lower rates Impact of the enactment of the TCJA Impact of intangible property transf ers Foreign-derived intangible income deduction State income taxes, net of f ederal benef it Research and development credit Excess tax benef its relating to stock-based compensation Interest, net Other reconciling items, net Ef f ective rate 2020 2018 2019 21.0% 21.0% 28.1% (4.1)% (7.8)% (3.7)% 0.4% 37.7% 0% 0% (5.9)% 0% 0% (1.4)% (1.1)% 0.7% 1.3% 1.3% (1.3)% (1.1)% (1.1)% (2.5)% (2.2)% (2.2)% 1.2% 1.0% 1.0% 1.3% (2.1)% 1.8% 16.5% 10.2% 54.6% The decrease f rom the f ederal statutory rate in f iscal year 2020 is primarily due to earnings taxed at lower rates in f oreign jurisdictions resulting f rom producing and distributing our products and services through our f oreign regional operations centers in Ireland and Puerto Rico, and tax benef its relating to stock -based compensation. The decrease f rom the f ederal statutory rate in f iscal year 2019 is primarily due to a $2.6 billion net income tax benef it related to intangible property transf ers, and earnings taxed at lower rates in f oreign jurisdictions resulting f rom producing and distributing our products and services through our f oreign regional operations centers in Ireland, Singapore, and Puerto Rico. The increase f rom the f ederal statutory rate in f iscal year 2018 is primarily due to the net charge related to the enactment of the TCJA in the second quarter of f iscal year 2018, of f set in part by earnings taxed at lower rates in f oreign jurisdictions. In f iscal year 2020, o ur f oreign regional operating centers in Ireland and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 86% of our f oreign income bef ore tax. In f iscal years 2019 and 2018, our f oreign regional operating centers in Ireland, Singapore, and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 82% and 87% of our f oreign income bef ore tax, respectively. Other reconciling items, net consists primarily of tax credits and GILTI tax. In f iscal year s 2020, 2019, and 2018, there were no individually signif icant other reconciling items. The increase in our ef f ective tax rate f or f iscal year 2020 compared to f iscal year 2019 was primarily due to a $2.6 billion net income tax benef it in the f ourth quarter of f iscal year 2019 related to intangible property transf ers. The decrease in our ef f ective tax rate f or f iscal year 2019 compared to f iscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of f iscal year 2018, and a $2.6 billion net income tax benef it in the f ourth quarter of f iscal year 2019 related to intangible property transf ers. 71 The components of the def erred income tax assets and liabilities were as f ollows: (In millions) June 30, Deferred Income Tax Assets Stock-based compensation expense Accruals, reserves, and other expenses Loss and credit carryf orwards Depreciation and amortization Leasing liabilities Unearned revenue Other Def erred income tax assets Less valuation allowance Def erred income tax assets, net of valuation allowance Deferred Income Tax Liabilities Book/tax basis differences in investments and debt Unearned revenue Leasing assets Def erred GILTI tax liabilities Other Def erred income tax liabilities Net def erred income tax assets Reported As Other long-term assets Long-term def erred income tax liabilities Net def erred income tax assets 2020 2019 $ 461 $ 2,721 865 6,361 3,025 1,553 354 15,340 (755) 406 2,287 3,518 7,046 1,594 475 367 15,693 (3,214) $ 14,585 $ 12,479 $ $ $ $ $ (2,642) $ 0 (2,817) (2,581) (344) (738) (30) (1,510) (2,607) (291) (8,384) $ (5,176) 6,201 $ 7,303 6,405 $ 7,536 (204) (233) 6,201 $ 7,303 Def erred income tax balances ref lect the ef f ects of temporary dif f erences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in ef f ect when the taxes are paid or recovered. As of June 30, 2020, we had f ederal, state, and f oreign net operating loss carryf orwards of $547 million, $975 million, and $2.0 billion, respectively. The f ederal and state net operating loss carryf orwards will expire in various years f rom f iscal 2021 through 2040, if not utilized. The majority of our f oreign net operating loss carryf orwards do not expire. Certain acquired net operating loss carryf orwards are subject to an annual limitation, but are expected to be realized with the exception of those which have a valuation allowance. The valuation allowance disclosed in the table above relates to the f oreign net operating loss carryf orwards and other net def erred tax assets that may not be realized. In f iscal year 2020, we removed $2.0 billion of f oreign net operating losses and corresponding valuation allowances as a result of the liquidation of a f oreign subsidiary. There was no impact to our consolidated f inancial statements. Income taxes paid, net of ref unds, were $12.5 billion, $8.4 billion, and $5.5 billion in f iscal years 2020, 2019, and 2018, respectively. Uncertain Tax Positions Gross unrecognized tax benef its related to uncertain tax positions as of June 30, 2020, 2019, and 2018, were $13.8 billion, $13.1 billion, and $12.0 billion, respectively, which were primarily included in long -term income taxes in 72 our consolidated balance sheets. If recognized, the resulting tax benef it would af f ect our ef f ective tax rates f or f iscal years 2020, 2019, and 2018 by $12.1 billion, $12.0 billion, and $11.3 billion, respectively. As of June 30, 2020, 2019, and 2018, we had accrued interest expense related to uncertain tax positions of $4.0 billion, $3.4 billion, and $3.0 billion, respectively, net of income tax benef its. The provision f or income taxes f or f iscal years 2020, 2019, and 2018 included interest expense related to uncertain tax positions of $579 million, $515 million, and $688 million, respectively, net of income tax benef its. The aggregate changes in the gross unrecognized tax benef its related to uncertain tax positions were as f ollows: (In millions) Year Ended June 30, Beginning unrecognized tax benef its Decreases related to settlements Increases f or tax positions related to the current year Increases f or tax positions related to prior years Decreases f or tax positions related to prior years Decreases due to lapsed statutes of limitations Ending unrecognized tax benef its 2020 2019 2018 $ 13,146 $ 11,961 $ 11,737 (193) 1,445 151 (1,176) (3) $ 13,792 $ 13,146 $ 11,961 (316) 2,106 508 (1,113) 0 (31) 647 366 (331) (5) We settled a portion of the Internal Revenue Service (“IRS”) audit f or tax years 2004 to 2006 in f iscal year 2011. In Februar y 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues f or tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit f or tax years 2007 to 2009 in f iscal year 2016, and a portion of the IRS audit f or tax years 2010 to 2013 in f iscal year 2018. We remain under audit f or tax years 2004 to 2013. In April 2020, the IRS commenced the audit f or tax years 2014 to 2017. As of June 30, 2020, the primary unresolved issues f or the IRS audits relate to transf er pricing, which could have a material impact in our consolidated f inancial statements when the matters are resolved. We believe our allowances f or income tax contingencies are adequate. We have not received a proposed assessment f or the unresolved issues and do not expect a f inal resolution of these issues in the next 12 months. Based on the inf ormation currently available, we do not anticipate a signif icant increase or decrease to our tax contingencies f or these issues within the next 12 months. We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination f or tax years 1996 to 2019, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated f inancial statements. NOTE 13 — UNEARNED REVENUE Unearned revenue by segment was as f ollows: (In millions) June 30, Productivity and Business Processes Intelligent Cloud More Personal Computing Total 2020 2019 $ 18,643 $ 16,831 16,988 16,620 3,387 3,917 $ 39,180 $ 37,206 73 Changes in unearned revenue were as f ollows: (In millions) Year Ended June 30, 2020 Balance, beginning of period Def erral of revenue Recognition of unearned revenue Balance, end of period $ 37,206 78,922 (76,948) $ 39,180 Revenue allocated to remaining perf ormance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in f uture periods, was $111 billion as of June 30, 2020, of which $107 billion is related to the commercial portion of revenue. We expect to recognize approximately 50% of this revenue over the next 12 months and the remainder thereaf ter. NOTE 14 — LEASES We have operating and f inance leases f or datacenters, corporate of f ices, research and development f aciliti es, retail stores, and certain equipment. Our leases have remaining lease terms of 1 year to 20 years, some of which include options to extend the leases f or up to 5 years, and some of which include options to terminate the leases within 1 year. The components of lease expense were as f ollows: 2020 2018 $ 2,043 $ 1,707 $ 1,585 2019 $ $ 611 $ 336 947 $ 370 $ 247 617 $ 243 175 418 2020 2019 2018 $ 1,829 $ 1,670 $ 1,522 175 144 247 221 336 409 3,677 3,467 2,303 2,532 1,571 1,933 (In millions) Year Ended June 30, Operating lease cost Finance lease cost: Amortization of right-of -use assets Interest on lease liabilities Total f inance lease cost Supplemental cash f low inf ormation related to leases was as f ollows: (In millions) Year Ended June 30, Cash paid f or amounts included in the measurement of lease liabilities: Operating cash f lows f rom operating leases Operating cash f lows f rom f inance leases Financing cash f lows f rom f inance leases Right-of -use assets obtained in exchange f or lease obligations: Operating leases Finance leases 74 Supplemental balance sheet inf ormation related to leases was as f ollows: (In millions, except lease term and discount rate) June 30, Operating Leases Operating lease right-of -use assets Other current liabilities Operating lease liabilities Total operating lease liabilities Finance Leases Property and equipment, at cost Accumulated depreciation Property and equipment, net Other current liabilities Other long-term liabilities Total f inance lease liabilities Weighted Average Remaining Lease Term Operating leases Finance leases Weighted Average Discount Rate Operating leases Finance leases Maturities of lease liabilities were as f ollows: (In millions) Year Ending June 30, 2021 2022 2023 2024 2025 Thereaf ter Total lease payments Less imputed interest Total 2020 2019 $ $ 8,753 $ 7,379 1,515 6,188 7,703 1,616 $ 7,671 9,287 $ $ $ 10,371 $ (1,385) 8,986 $ 540 $ $ $ 8,956 9,496 $ $ 7,041 (774) 6,267 317 6,257 6,574 8 years 13 years 7 years 13 years 2.7% 3.9% 3.0% 4.6% Operating Leases $ 1,807 $ 1,652 1,474 1,262 1,000 3,122 10,317 (1,030) Finance Leases 880 894 903 916 1,236 7,194 12,023 (2,527) $ 9,287 $ 9,496 As of June 30, 2020, we have additional operating and f inance leases, primarily f or datacenters, that have not yet commenced of $3.4 billion and $3.5 billion, respectively. These operating and f inance leases will commence between f iscal year 2021 and f iscal year 2023 with lease terms of 1 year to 16 years. During f iscal year 2020, we recorded an impairment charge of $161 million to operating lease right-of -use assets due to the closing of our Microsoft Store physical locations. NOTE 15 — CONTINGENCIES Patent and Intellectual Property Claims There were 64 patent inf ringement cases pending against Microsof t as of June 30, 2020, none of which are material individually or in aggregate. 75 Antitrust, Unfair Competition, and Overcharge Class Actions Antitrust and unf air competition class action lawsuits were f iled against us in British Columbia, Ontario, and Quebec, Canada. All three have been certif ied on behalf of Canadian indirect purchasers who acquired licenses f or Microsoft operating system sof tware and/or productivity application software between 1998 and 2010. The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions, and submitted the proposed settlem ent agreement to the courts in all three jurisdictions f or approval. The f inal settlement has been approved by the courts in British Columbia, Ontario, and Quebec, and the claims administration process will commence once each court approves the f orm of not ice to the class. Other Antitrust Litigation and Claims China State Administration for Industry and Commerce Investigation In 2014, Microsof t was inf ormed that China’s State Agency f or Market Regulation (“SAMR”) (f ormerly State Administration f or Industry and Commerce) had begun a f ormal investigation relating to China’s Anti -Monopoly Law, and the SAMR conducted onsite inspections of Microsoft of f ices in Beijing, Shanghai, Guangzhou, and Chengdu. The SAMR has presented its preliminary views as to certain possible violations of China’s Anti -Monopoly Law, and discussions are expected to continue. Product-Related Litigation U.S. Cell Phone Litigation Microsof t Mobile Oy, a subsidiary of Microsof t, along with other handset manuf acturers and network operators, is a def endant in 40 lawsuits f iled in the Superior Court f or the District of Columbia by individual plaintif f s who allege that radio emissions f rom cellular handsets caused their brain tumors and other adverse health ef f ects. We assumed responsibility f or these claims in our agreement to acquire Nokia’s Devices and Services business and have been substituted f or the Nokia def endants. Nine of these cases were f iled in 2002 and are consolidated f or certain pre-trial proceedings; the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals f or the District of Columbia held that adverse health ef f ect claims arising f rom the use of cellular handsets that operate within the U.S. Federal Communications Commission radio f requency emission guidelines (“FCC Guidelines”) are pre-empted by f ederal law. The plaintif f s allege that their handsets either operated outside the FCC Guidelines or were manuf actured bef ore the FCC Guidelines went into ef f ect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines. In 2013, the def endants in the consolidated cases mo ved to exclude the plaintif f s’ expert evidence of general causation on the basis of f lawed scientif ic methodologies. In 2014, the trial court granted in part and denied in part the def endants’ mot ion to exclude the plaintif f s’ general causation experts. The def endants f iled an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard f or evaluating expert scientif ic evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the def endants and remanding the cases to the trial court f or f urther proceedings under that standard. The plaintif f s have f iled supplemental expert evidence, portions of which the def endants have moved to strike. In August 2018, the trial court issued an order s triking portions of the plaintif f s’ expert reports. A hearing is expected to occur in the second quarter of f iscal year 2021. Other Contingencies We also are subject to a variety of other claims and suits that arise f rom time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact in our consolidated f inancial statements, these matters are subject to inherent uncertainties and management’s view of these matters may change in the f uture. 76 As of June 30, 2020, we accrued aggregate legal liabilities of $306 million. While we intend to def end these matters vigorously, adverse outcomes that we estimate could reach approximately $500 million in aggregate beyond recorded amounts are reasonably possible. Were unf avorable f inal outcomes to occur, there exists the possibility of a material adverse impact in our consolidated f inancial statements f or the period in which the ef f ects b ecome reasonably estimable. Shares Outstanding Shares of common stock outstanding were as f ollows: NOTE 16 — STOCKHOLDERS’ EQUITY (In millions) Year Ended June 30, Balance, beginning of year Issued Repurchased Balance, end of year Share Repurchases 2020 7,643 54 (126) 7,571 2019 7,677 116 (150) 7,643 2018 7,708 68 (99) 7,677 On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. This share repurchase program commenced in December 2016 and was completed in February 2020. On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. This share repurchase program commenced in February 2020, f ollowing completion of the program approved on September 20, 2016, has no expiration date, and may be terminated at any time. As of June 30, 2020, $31.7 billion remained of this $40.0 billion share repurchase program. We repurchased the f ollowing shares of common stock under the share repurchase programs: (In millions) Year Ended June 30, First Quarter Second Quarter Third Quarter Fourth Quarter Total Shares Amount Shares Amount Shares 2020 29 $ 4,000 4,600 32 6,000 37 5,088 28 126 $ 19,688 2019 24 $ 2,600 6,100 57 3,899 36 33 4,200 150 $ 16,799 Amount 2018 22 $ 1,600 1,800 22 3,100 34 21 2,100 99 $ 8,600 Shares repurchased during the f ourth quarter of f iscal year 2020 were under the share repurchase program approved on September 18, 2019. Shares repurchased during the third quarter of f iscal year 2020 were under the share repurchase programs approved on both September 20, 2016 and September 18, 2019. All other shares repurchased were under the share repurchase program approved on September 20, 2016. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stoc k awards of $3.3 billion, $2.7 billion, and $2.1 billion f or f iscal years 2020, 2019, and 2018, respectively. All share repurchases were made using cash resources. 77 Dividends Our Board of Directors declared the f ollowing dividends: Declaration Date Fiscal Year 2020 September 18, 2019 December 4, 2019 March 9, 2020 June 17, 2020 Total Fiscal Year 2019 September 18, 2018 November 28, 2018 March 11, 2019 June 12, 2019 Total Record Date Payment Date November 21, 2019 December 12, 2019 March 12, 2020 June 11, 2020 August 20, 2020 September 10, 2020 February 20, 2020 May 21, 2020 November 15, 2018 February 21, 2019 May 16, 2019 December 13, 2018 March 14, 2019 June 13, 2019 August 15, 2019 September 12, 2019 Dividend Per Share $ 0.51 0.51 0.51 0.51 $ 2.04 Amount (In millions) $ 3,886 3,876 3,865 3,861 $ 15,488 $ 0.46 0.46 0.46 0.46 $ 1.84 $ 3,544 3,526 3,521 3,510 $ 14,101 The dividend declared on June 17, 2020 was included in other current liabilities as of June 30, 2020. NOTE 17 — ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The f ollowing table summarizes the changes in accumulated other comprehensive income (loss) by c omponent: (In millions) Year Ended June 30, Derivatives Balance, beginning of period Unrealized gains (losses), net of tax of $(10), $2, and $11 Reclassif ication adjustments f or gains included in revenue Tax expense included in provision f or income taxes Amounts reclassif ied f rom accumulated other comprehensive income (loss) Net change related to derivatives, net of tax of $(10), $(6), and $5 Balance, end of period Investments Balance, beginning of period Unrealized gains (losses), net of tax of $1,057, $616, and $(427) Reclassif ication adjustments f or (gains) losses included in other income (expense), net Tax expense (benef it) included in provision f or income taxes Amounts reclassif ied f rom accumulated other comprehensive income (loss) Net change related to investments, net of tax of $1,058, $635, and $(1,165) Cumulative ef f ect of accounting changes Balance, end of period Translation Adjustments and Other Balance, beginning of period Translation adjustments and other, net of tax ef f ects of $1, $(1), and $0 Balance, end of period Accumulated other comprehensive income (loss), end of period 78 2020 2019 2018 $ $ 0 $ (38) 0 0 0 (38) (38) $ 173 $ 160 (341) 8 (333) (173) 0 $ 134 218 (185) 6 (179) 39 173 $ 1,488 $ 3,987 (850) $ 1,825 (1,146) 2,331 4 (1) 3 3,990 0 93 (19) 74 2,405 (67) $ 5,478 $ 1,488 $ (2,309) 738 (1,571) (2,717) 42 (850) $ (1,828) $ (1,510) $ (1,332) (178) (426) (318) $ (1,828 ) $ (2,254) $ 3,186 $ $ (1,510) (340) $ (2,187) NOTE 18 — EMPLOYEE STOCK AND SAVINGS PLANS We grant stock-based compensation to employees and directors. As of June 30, 2020, an aggregate of 283 million shares were authorized f or f uture grant under our stock plans. Awards that expire or are canceled without delivery of shares generally become available f or issuance under the plans. We issue new shares of Microsof t common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP f or all eligible employees. Stock-based compensation expense and related income tax benef it s were as f ollows: (In millions) Year Ended June 30, Stock-based compensation expense Income tax benef its related to stock-based compensation Stock Plans 2020 $ 5,289 938 2019 $ 4,652 816 2018 $ 3,940 823 Stock awards entitle the holder to receive shares of Microsof t common stock as the award vests. Stock awards generally vest over a service period of f our years or f ive years. Executive Incentive Plan Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive of f icers and certain senior executives. RSUs generally vest ratably over a service period of f our years. PSUs generally vest over a perf ormance period of three years. The number of shares the PSU holder receives is based on the extent to which the corresponding perf ormance goals have been achieved. Activity for All Stock Plans The f air value of stock awards was estimated on the date of grant using the f ollowing assumptions: Year ended June 30, Dividends per share (quarterly amounts) Interest rates 2020 2018 $ 0.46 - 0.51 $ 0.42 - 0.46 $ 0.39 - 0.42 1.7% - 2.9% 1.8% - 3.1% 0.1% - 2.2% 2019 During f iscal year 2020, the f ollowing activity occurred under our stock plans: Stock Awards Nonvested balance, beginning of year Granted (a) Vested Forf eited Nonvested balance, end of year Weighted Average Grant-Date Fair Value Shares (In millions) 147 53 (65) (9) 126 $ 78.49 140.49 75.35 90.30 $ 105.23 (a) Includes 2 million, 2 million, and 3 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2020, 2019, and 2018, respectively. 79 As of June 30, 2020, there was approximately $10.2 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of three years. The weighted average grant-date f air value of stock awards granted was $140.49, $107.02, and $75.88 f or f iscal years 2020, 2019, and 2018, respectively. The f air value of stock awards vested was $10.1 billion, $8.7 billion, and $6.6 billion, f or f iscal years 2020, 2019, and 2018, respectively. Employee Stock Purchase Plan We have an ESPP f or all eligible employees. Shares of our common stock may be purchased by employees at three -month intervals at 90% of the f air 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 of f ering period. Employees purchased the f ollowing shares during the periods presented: (Shares in millions) Year Ended June 30, Shares purchased Average price per share 2020 9 $ 142.22 2019 11 $ 104.85 2018 13 $ 76.40 As of June 30, 2020, 96 million shares of our common stock were reserved f or f uture issuance through the ESPP. Savings Plan We have savings plans in the U.S. that qualif y under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We contribute f if ty cents f or each dollar a participant contributes into the plans, with a ma ximum employer contribution of 50% of the IRS contribution limit f or the calendar year. Employer-f unded retirement benef its f or all plans were $1.0 billion, $877 million, and $807 million in f iscal years 2020, 2019, and 2018, respectively, and were expensed as contributed. NOTE 19 — SEGMENT INFORMATION AND GEOGRAPHIC DATA In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Of f icer, reviews certain f inancial inf ormation, including segmented internal p rof it and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our f inancial perf ormance based on the f ollowing segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing . Our reportable segments are described below. Productivity and Business Processes Our Productivity and Business Processes segment consists of products and services in our portf olio of productivity, communication, and inf ormation services, spanning a variety of devices and platf orms. This segment primarily comprises: • Of f ice Commercial, including Of f ice 365 subscriptions, the Of f ice portion of Microsof t 365 Commercial subscriptions, and Of f ice licensed on-premises, comprising Of f ice, Exchange, SharePoint, Microsof t Teams, Of f ice 365 Security and Compliance, and Skype f or Business, and related Client Access Licenses (“CALs”). • Of f ice Consumer, including Microsof t 365 Consumer (f ormerly Of f ice 365 Consumer) subscriptions and Of f ice • licensed on-premises, and Of f ice Consumer Services, including Skype, Outlook.com, and OneDrive. LinkedIn, including Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions. • Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises. 80 Intelligent Cloud Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises: • Server products and cloud services, including Azure; SQL Server, Windows Server, Visual Studio, System Center, and related CALs; and GitHub. • Enterprise Services, including Premier Support Services and Microsof t Consulting Services. More Personal Computing Our More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises: • Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial of f erings; patent licensing; Windows Internet of Things; and MSN advertising. • Devices, including Surf ace and PC accessories. • Gaming, including Xbox hardware and Xbox content and services, comprising Xbox Live (transactions, subscriptions, cloud services, and advertising), video games, and third -party video game royalties. • Search. Revenue and costs are generally directly attributed to our segment s. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benef it other segments. Revenue f rom certain contracts is allocated among the segments based on the relative value of the underlyi ng products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating ex penses that are allocated primarily include those relating to marketing of products and services f rom which multiple segments benef it and are generally allocated based on relative gross margin. In addition, certain costs incurred at a corporate level that are identif iable and that benef it our segments are allocated to them. These allocated costs include costs of : legal, including settlements and f ines; inf ormation technology; human resources; f inance; excise taxes; f ield selling; shared f acilities services ; and customer service and support. Each allocation is measured dif ferently based on the specif ic f acts and circumstances of the costs being allocated. Certain corporate -level activity is not allocated to our segments. Segment revenue and operating income were as f ollows during the periods presented: (In millions) Year Ended June 30, Revenue Productivity and Business Processes Intelligent Cloud More Personal Computing Total Operating Income Productivity and Business Processes Intelligent Cloud More Personal Computing Total 2020 2019 2018 $ 46,398 $ 48,366 48,251 35,865 32,219 42,276 $ 143,015 $ 125,843 $ 110,360 41,160 $ 38,985 45,698 $ 18,724 $ 18,324 15,911 $ 52,959 $ 16,219 $ 13,920 12,820 42,959 $ 12,924 11,524 10,610 35,058 81 No sales to an individual customer or country other than the United States accounted f or more than 10% of revenue f or f iscal years 2020, 2019, or 2018. Revenue, classif ied by the major geographic areas in which our customers were located, was as f ollows: (In millions) Year Ended June 30, United States (a) Other countries Total 2020 $ 73,160 $ 69,855 2018 55,926 54,434 $ 143,015 $ 125,843 $ 110,360 2019 64,199 $ 61,644 (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 f rom external customers, classif ied by significant product and service of f erings, was as f ollows: (In millions) Year Ended June 30, Server products and cloud services Of f ice products and cloud services Windows Gaming LinkedIn Search advertising Devices Enterprise Services Other Total 2019 2020 $ 41,379 $ 32,622 $ 2018 26,129 28,316 19,518 10,353 5,259 7,012 5,134 5,846 2,793 $ 143,015 $ 125,843 $ 110,360 31,769 20,395 11,386 6,754 7,628 6,095 6,124 3,070 35,316 22,294 11,575 8,077 7,740 6,457 6,409 3,768 Our commercial cloud revenue, which includes Of f ice 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $51.7 billion, $38.1 billion and $26.6 billion in f iscal years 2020, 2019, and 2018, respectively. These amounts are primarily included in Of f ice products and cloud services, Server products and cloud services, and LinkedIn in the table above. Assets are not allocated to segments f or internal reporting presentations. A portion of amortizatio n and depreciation is included with various other costs in an overhead allocation to each segment. It is impracticable f or us to separately identif y the amount of amortization and depreciation by segment that is included in the measure of segment prof it or loss. Long-lived assets, excluding f inancial instruments and tax assets, classif ied by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as f ollows: $ 2020 2018 2019 60,789 $ 55,252 $ 44,501 12,958 12,843 12,734 25,422 22,538 29,770 $ 103,293 $ 93,632 $ 79,882 (In millions) June 30, United States Ireland Other countries Total 82 NOTE 20 — QUARTERLY INFORMATION (UNAUDITED) (In millions, except per share amounts) Quarter Ended Fiscal Year 2020 Revenue Gross margin Operating income Net income Basic earnings per share Diluted earnings per share Fiscal Year 2019 Revenue Gross margin Operating income Net income (a) Basic earnings per share Diluted earnings per share (b) September 30 December 31 March 31 June 30 Total $ 33,055 22,649 12,686 10,678 1.40 1.38 29,084 19,179 9,955 8,824 1.15 1.14 $ 36,906 $ 35,021 $ 38,033 $ 143,015 96,937 24,548 52,959 13,891 44,281 11,649 5.82 1.53 5.76 1.51 24,046 12,975 10,752 1.41 1.40 25,694 13,407 11,202 1.48 1.46 32,471 20,048 10,258 8,420 1.09 1.08 30,571 20,401 10,341 8,809 1.15 1.14 33,717 23,305 12,405 13,187 1.72 1.71 125,843 82,933 42,959 39,240 5.11 5.06 (a) Reflects the $157 million net charge related to the enactment of the TCJA for the second quarter and the $2.6 billion net income tax benefit related to the intangible property transfers for the fourth quarter, which together increased net income by $2.4 billion for fiscal year 2019. See Note 12 – Income Taxes for further information. (b) Reflects the net charge related to the enactment of the TCJA and the net income tax benefit related to the intangible property transfers, which decreased (increased) diluted EPS $0.02 for the second quarter, $(0.34) for the fourth quarter, and $(0.31) for fiscal year 2019. 83 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft Corporation Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the “Company”) as of June 30, 2020 and 2019, the related consolidated statements of income, comprehensive income, cash f lows, and stockholders’ equity, f or each of the three years in the period ended June 30, 2020, and the related notes (collectively ref erred to as the “f inancial statements”). In our opinion, the f inancial statements present f airly, in all material respects, the f inancial position of the Company as of June 30, 2020 and 2019, and the results of its operations and its cash f lows for each of the three years in the period ended June 30, 2020, in conf ormity 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) (PCAOB), the Company’s internal co ntrol over f inancial reporting as of June 30, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 30, 2020, expressed an unqualif ied opinion on the Company’s internal control over f inancial reporting. Basis for Opinion These f inancial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s f inancial statements based on our audits. We are a public accounting f irm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. f ederal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perf orm the audit to obtain reasonable assurance about whether the f inancial statements are f ree o f material misstatement, whether due to error or f raud. Our audits included perf orming procedures to assess the risks of material misstatement of the f inancia l statements, whether due to error or f raud, and perf orming procedures that respond to those risks . Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the f inancial statements. Our audits also included evaluating the accounting principles used and signif icant estimates made by management, as well as e valuating the overall presentation of the f inancial statements. We believe that our audits provide a reasonable basis f or our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising f rom the current -period audit of the f inancial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the f inancial statements and (2) involved our especially challenging, subjective, o r complex judgments. The communication of critical audit matters does not alter in any way our opinion on the f inancial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. 84 Revenue Recognition — Refer to Note 1 to the financial statements Critical Audit Matter Description The Company recognizes revenue upon transf er of control of promised products or services to customers in an amount that ref lects the consideration the Company expects to receive in exchange f or those products or services. The Company of fers customers the ability to acquire multiple licenses of sof tware products and services, including cloud -based services, in its customer agreements through its volume licensing programs. Signif icant judgment is exercised by the Company in determining revenue recognition f o r these customer agreements, and includes the f ollowing: • Determination of whether products and services are considered distinct perf ormance obligations that should be accounted f or separately versus together, such as sof tware licenses and related servic es that are sold with cloud-based services. • The pattern of delivery (i.e., timing of when revenue is recognized) f or each distinct perf ormance obligation. • Identif ication and treatment of contract terms that may impact the timing and amount of revenue recognized (e.g., variable consideration, optional purchases, and f ree services). • Determination of stand-alone selling prices f or each distinct perf ormance obligation and f or products and services that are not sold separately. Given these f actors and due to the volume of transactions, the related audit ef f ort in evaluating management’s judgments in determining revenue recognition f or these customer agreements was extensive and required a high degree of auditor judgment. How the Critical Audit Matter Was Addressed in the Audit Our principal audit procedures related to the Company’s revenue recognition f or these customer agreements included the f ollowing: • We tested the ef f ectiveness of controls related to the identif ication of distinct perf ormance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration. • We evaluated management’s signif icant accounting policies related to these customer agreements f or reasonableness. • We selected a sample of customer agreements and perf ormed the f ollowing procedures: - Obtained and read contract source documents f or each selection, including master agreements, and other documents that were part of the agreement. Tested management’s identif ication and treatment of contract terms. - - Assessed the terms in the customer agreement and evaluated the appropriateness of management’s application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions. • We evaluated the reasonableness of management’s estimate of stand-alone selling prices f or products and services that are not sold separately. • We tested the mathematical accuracy of management’s calculations of revenue and the associated timing of revenue recognized in the f inancial statements. 85 Income Taxes — Uncertain Tax Positions — Refer to Note 12 to the financial statements Critical Audit Matter Description The Company’s long-term income taxes liability includes uncertain tax positions related to transf er pricing issues that remain unresolved with the Internal Revenue Service (“IRS”). The Company remains under IRS audit, or subject to IRS audit, f or tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Company’s f inancial statements. Conclusions on recognizing and measuring uncertain tax positions involv e significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior -year audit settlements. Given the complexity and the subjective nature of the transf er pricing is sues that remain unresolved with the IRS, evaluating management’s estimates relating to their determination of uncertain tax positions required extensive audit ef f ort and a high degree of auditor judgment, including involvement of our tax specialists. How the Critical Audit Matter Was Addressed in the Audit Our principal audit procedures to evaluate management’s estimates of uncertain tax positions related to unresolved transf er pricing issues included the f ollowing: • We evaluated the appropriateness and consistency of management’s methods and assumptions used in the tax positions, which included testing the identif ication, recognition, measurement, and disclosure of uncertain ef f ectiveness of the related internal controls. • We read and evaluated management’s documentation, including relevant accounting policies and inf ormation obtained by management f rom outside tax specialists, that detailed the basis of the uncertain tax positions. • We tested the reasonableness of management’s judgments regarding t he f uture resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions. • For those uncertain tax positions that had not been ef f ectively settled, we evaluated whether management had appropriately considered new inf ormation that could signif icantly change the recognition, measurement or disclosure of the uncertain tax positions. • We evaluated the reasonableness of management’s estimates by considering how tax law, including statutes, regulations and case law, impacted management’s judgments. /s/ DELOITTE & TOUCHE LLP Seattle, Washington July 30, 2020 We have served as the Company’s auditor since 1983. 86 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including the Chief Executive Of f icer and Chief Financial Of f icer, we have evaluated the ef f ectiveness 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 Of f icer and Chief Financial Of f icer have concluded that these disclosure controls and procedures are ef f ective. REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible f or establishing and maintaining adequate internal control over f inancial reporting f or the Company. Internal control over f inancial reporting is a process to provide reasonable assurance regarding the re liability of our f inancial reporting f or external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over f inancial reporting includes maintaining records that in reasonable detail accurat ely and f airly ref lect our transactions; providing reasonable assurance that transactions are recorded as necessary f or preparation of our consolidated f inancial 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 ef f ect on our consolidated f inancial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over f inancial reporting is not intended to provide absolute assurance that a misstatement of our consolidated f inancial statements would be prevented or detected. Management conducted an evaluation of the ef f ectiveness of our internal control over f inancial reporting based on the f ramework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Company’s internal control over f inancial reporting was ef f ective as of June 30, 2020. There were no changes in our internal control over f inancial reporting during the quarter ended June 30, 2020 that have materially af f ected, or are reasonably likely to materially af f ect, our internal control over f inancial reporting. Deloitte & Touche LLP has audited our internal control over f inancial reporting as of June 30, 2020; their report f ollows. 87 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and the Board of Directors of Microsoft Corporation Opinion on Internal Control over Financial Reporting We have audited the internal control over f inancial reporting of Microsoft Corporation and subsidiaries (the “Company”) as of June 30, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, ef f ective internal control over f inancial reporting as of June 30, 2020, based on the criteria established in Internal Control – Integrated Framework (2013) issued by COSO. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated f inancial statements and the related notes (collectively ref erred to as the “f inancial statements”) as of and f or the year ended June 30, 2020, of the Company and our report dated July 30, 2020, expressed an unqualif ied opinion on those f inancial statements. Basis for Opinion The Company’s management is responsible f or maintaining ef f ective internal control over f inancial reporting and f or its assessment of the ef f ectiveness of internal control over f inancial 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 f inancial reporting b ased on our audit. We are a public accounting f irm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. f ederal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perf orm the audit to obtain reasonable assurance about whether ef f ective internal control over f inancial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over f inancial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating ef f ectiveness of i nternal control based on the assessed risk, and perf orming such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis f or our opinion. Definition and Limitations of Internal Control over Financial Reporting A company’s internal control over f inancial reporting is a process designed to provide reasonable assurance regarding the reliability of f inancial reporting and the preparation of f inancial statements f or external purposes in accordance with generally accepted accounting principles. A company’s internal control over f inancial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and f airly ref lect the transac tions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of f inancial 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 ef f ect on the f inancial statements. Because of its inherent limitations, internal control over f inancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of ef f ectiveness to f uture periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ DELOITTE & TOUCHE LLP Seattle, Washington July 30, 2020 88 DIRECTORS AND EXECUTIVE OFFICERS OF MICROSOFT CORPORATION John W. Thompson 3,4 Independent Board Chair, Microsof t Corporation Reid G. Hoffman Partner, Greylock Partners Hugh F. Johnston 1 Vice Chairman, Executive Vice President, and Chief Financial Of f icer, PepsiCo DIRECTORS Satya Nadella Chief Executive Of f icer, Microsof t Corporation Sandra E. Peterson 2,3 Operating Partner, Clayton, Dubilier & Rice Arne M. Sorenson 1 President and Chief Executive Of f icer, Marriott International, Inc. John W. Stanton 1,4 Founder and Chairman, Trilogy Partnerships Penny S. Pritzker 4 Founder and Chairman, PSP Partners Emma N. Walmsley 2,4 Chief Executive Of f icer, GlaxoSmithKline Teri L. List-Stoll 1,3 Former Executive Vice President and Chief Financial Of f icer, The Gap, Inc. Charles W. Scharf 2,3 President and Chief Executive Of f icer, Wells Fargo & Company Padmasree Warrior 2 Founder, Chief Executive Of f icer and President, Fable Group Inc. Audit Committee Board Committees 1. 2. Compensation Committee 3. Governance and Nominating Committee 4. Regulatory and Public Policy Committee EXECUTIVE OFFICERS Satya Nadella Chief Executive Of f icer Christopher C. Capossela Executive Vice President, Marketing and Consumer Business, and Chief Marketing Of f icer Jean-Philippe Courtois Executive Vice President and President, Microsof t Global Sales, Marketing and Operations Kathleen T. Hogan Executive Vice President, Human Resources Amy E. Hood Executive Vice President, Chief Financial Of f icer Bradford L. Smith President and Chief Legal Of f icer 89 INVESTOR RELATIONS Investor Relations You can contact Microsof t Investor Relations at any time to order f inancial documents such as annual reports and Form 10-Ks f ree of charge. Call us toll-f ree at (800) 285-7772 or outside the United States, call (425) 706-4400. We can be contacted between the hours of 9:00 a.m. to 5:00 p.m. Pacif ic Time to answer investment oriented questions about Microsof t. For access to additional f inancial inf ormation, visit the Investor Relations website online at: www.microsof t.com/investor Our e-mail is msf t@microsoft.com Our mailing address is: Investor Relations Microsof t Corporation One Microsof t Way Redmond, Washington 98052-6399 Attending the Annual Meeting The 2020 Annual Shareholders Meeting will be held as a virtual-only meeting. Any shareholder can join the Annual Meeting, while shareholders of record as of October 8, 2020 will be able to vote and submit questions during the meeting. Date: Wednesday, December 2, 2020 Time: 8:00 a.m. Pacif ic Time Virtual Shareholder Meeting: www.virtualshareholdermeeting.com/MSFT20 Submit Your Question We invite you to submit any questions via the proxy vot ing site at www.proxyvote.com. We will include as many of your questions as possible during the Q&A session of the meeting and will provide answers to questions on the Microsof t Investor Relations website under the Annual Meeting page. 90 Registered Shareholder Services Computershare, our transf er agent, can help you with a variety of shareholder related services including: • • • • Change of address Lost stock certificates Transf er of stock to another person Additional administrative services Computershare also administers a direct stock purchase plan and a dividend reinvestment program f or the company. Contact Computershare directly to find out more about these services and programs at 800-285-7772, option 1, or visit online at: https://www.computershare.com/Microsoft You can e-mail the transf er agent at: web.queries@computershare.com You can also send mail to the transf er agent at: Computershare P.O. Box 505000 Louisville, KY 40233-5000 Shareholders can sign up f or electronic alerts to access the annual report and proxy statement online. The service gets you the inf ormation you need f aster and also gives you the power and convenience of online proxy voting. To sign up for this f ree service, visit the Annual Report site on the Investor Relations website at: http://www.microsoft.com/investor/AnnualReports/default. aspx (“ESG”)/Corporate Environmental, Social, Governance Social Responsibility (“CSR”) Many of our shareholders are increasingly f ocused on the importance of the ef f ective engagement and action on ESG topics. To meet the expectations of our stakeholders and to and maintain their trust, we are committed to conducting our business in ways that are principled, transparent, and accountable and we have made a broad range of environmental and social commitments. From our CEO and Senior Leadership Team and throughout our organization, people at Microsof t are working to conduct our business in principled ways that make a signif icant positive impact on important global issues. Microsoft’s Board of Directors provides insight, f eedback, and oversight across a broad range of environmental and social matters. In particular, among the responsibilities of the Board’s Regulatory and Public Policy Committee is to review and provide guidance to the Board and management about the Company’s policies and programs that relate to CSR. For more about Microsoft’s CSR commitments and perf ormance, please visit: www.microsof t.com/transparency  

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