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Glittering MS financials mask declining trend

It's easy to beat a street that co-operates - we explain how

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Microsoft's Q4 results "beat the street" again? Monotonous, isn't it? We'll explain how it happens. Wall Street financial analysts produce their estimates ahead of the results, and in this case the suggestion was that Microsoft would ear 36 cents a share. This estimate is then followed by a "whisper" figure that is little higher - 37 or 38 cents, these professional whisperers said in this case. But lo and behold, Microsoft reported 40 cents/share, with revenue of $5.764 billion for the quarter (up 29 per cent over the year earlier quarter, but a mere 15 per cent over the third quarter, which was in turn 12 per cent down on the second quarter), and net income of $2.202 billion (15 per cent above Q3). Since Microsoft's results are product driven rather than seasonally driven, there is now hard evidence that Microsoft is slowing down. In the conference call after the results were announced, Jerry Masters, senior director of planning and reporting, noted that there were "a few twists", and that Microsoft had "reclassified certain activities" that increased reported revenue but "there was no impact on the bottom line ". There was $200 million of coupon revenue from Office 2000 (the free upgrade for those who bought earlier versions recently). With only $285 million difference between the net income for Q3 and Q4, the real reason for Microsoft's change in accounting practices becomes clear: without the tricks, Microsoft would have shown a second quarter of decline in net income - something that will not be reported by most media, we suspect. Microsoft presented the results skilfully, with a long, boring justification that very carefully steered the less-than-astute financial analysts away from the true picture. It turns out that Microsoft's 30 June conference call for the analysts was to forestall any difficult questions about the changes in accounting practices that were needed to make Q4 look better than it was. In its defence, Microsoft can claim that the flexible rules of accounting allow a wide variation in how the accounts are presented. It will be interesting to see if the current Securities and Exchange Commission investigation of Microsoft finds evidence of Microsoft manipulating its share price by such means. Nobody seemed to be saying that the results were excellent evidence of monopoly profits, but it may not escape Judge Jackson when he decides whether Microsoft has competed illegally. Microsoft's business model is evolving towards licensing and away from packaged software. The sales pressure is to get organisations to sign multi-year licences, with the bigger deals being negotiated directly by Microsoft. Masters said this has resulted in lower channel inventory and hence lower returns from the channel, giving a saving of $250 million. For the financial year that ended 30 June, Microsoft banked $19.747 billion of revenue, up 29 per cent over the previous year, and had net income of $7.785 billion, up 73 per cent over FY 1998, a figure so obscene that Microsoft is too embarrassed to include it in its full announcement of the results. Although the balance sheet for the end of the FY shows $17.236 billion in cash and short-term deposits (compared with $13.927 billion a year earlier, the significant change is that "equity and other investments" went from $4.703 billion to $14.372 billion as a result of Ballmer's recent spending spree. Geographically, weak results in Latin America were disguised by including them within the result for the Americas, where a 30 per cent increase in revenue to $7.249 billion for the year was reported, and 48 per cent for Q4. EMEA reported a 24 per cent increase for the year, and 33 per cent for Q4. Asia was up 20 per cent on the year, and 53 per cent on the quarter, suggesting some recovery in Japan. OEM sales worldwide were up 37 per cent on the year, and 27 per cent on the quarter, which shows slowing OEM sales. The value of OEM sales exceeds EMEA and Asia sales combined. Microsoft only breaks down sales by product into three groups: Windows (up 35 per cent on the year, and 32 per cent on the quarter); "productivity applications & developer" - Office and tools - (up 25 per cent on the year, but 47 per cent on the quarter); and "consumer, commerce and other" (up 25 per cent on the year and 26 per cent on the quarter). There was deafening silence about contingency reserves if Microsoft loses the Caldera case, and the only mention of Microsoft's legal woes was that it had spent $150 million on "non-recurring legal expenses". We shall see. The true cost of Microsoft's various legal actions is many times this figure because of the executive time being spent on the defence. ®

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