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MS turns in whopping 41 per cent net profit

Nice work if you can get it - but the OEM sales team wouldn't let you...

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Despite Microsoft's first quarter ending 30 September showing 7 per cent lower revenue than the previous quarter, as well as net income down 0.5 per cent, this is not the story being reported today. Microsoft prefers to make comparisons with the year-earlier quarter, which shows its results in a better light. Revenue was $5.38 billion for the quarter, and net income $2.191 billion - a whopping 41 per cent profit. Looked at Microsoft's way, there was a 28 per cent increase in revenue and a 37 per cent increase in net income, compared with a year earlier. Cash and short-term investments amounted to $18.9 billion at the end of September. Earnings per share were 40 cents, two cents more than the First Call consensus estimate of 38 cents. It is suspected that Microsoft waits until the last minute to decide what the EPS will be, in order to be able to "beat the Street". On Monday, the Securities and Exchange Commission chairman Arthur Levitt criticised the behaviour of financial analysts in a speech, saying that there were "dysfunctional relationships" and that company results were tailored with an eye to consensus estimates [i.e. beating the Street], rather than "the ups and downs of business". At last it seems that these practices have caught the eye of the SEC. They are used outrageously to manipulate the share price by analysts whose employers (and who personally) often have significant stakes in the companies they're commenting on. Microsoft also uses the trick of excluding certain "special" items to make the results look better. This quarter it was Sidewalk, which had been sold for $160 million (possibly at a loss), while the year-earlier quarter included $160 million from the sale of Softimage. The result of this jiggery-pokery is to suggest a bigger percentage increase of net income. Speaking up for Microsoft's approach to the figures, CFO Greg Maffei claimed that sequential analysis of the results should not be used because of seasonal factors. However, an examination of Microsoft's revenues shows no such seasonal changes that justify using year-earlier figures. Revenue goes up or down depending on product cycles, and specifically the release dates of new versions of Windows and Office. In the past three years, revenue and income have decline sequentially in four quarters, twice in Q1, once in Q3, and once in Q4. Maffei became noticeably tense when he was questioned by an analyst from JP Morgan over the unearned revenue drop - the first ever. Maffei also made a comment that in "virtually every quarter" there had been a drop from Q2 to Q3 and from Q4 to Q1, and that this was seasonal. A glance at the quarterly data however quickly shows this is just not the case. Microsoft also makes a point of trying to turn bad news into good news, in the sure and certain knowledge that in most cases its headlines will be reported as it wishes. The "continued excellent Office sales" headline turns out differently in practice, since US Office sales were significantly weaker than expected as a result of competing products, especially in the consumer market. Office is seen to be too expensive to be bundled with most home PCs. Geographically, the bad performer was the Americas, which was up only 16 per cent on the year-earlier figures; EMEA was up 32 per cent; and Asia up 82 per cent - but the dollar amount of this increase was only $268 million. OEM sales worldwide were up 27 per cent on a year earlier. In all cases, there is a direct correlation between new PC sales and revenue. All Microsoft has to do is to sit at the till collecting the money: downward trends in PC prices are matched by upward trends in Microsoft software prices. Windows sales increased 17 per cent over the year, with productivity applications and developer tools showing an increase of 40 per cent. The Internet area grew 30 per cent, but is still only grossing $685 million. Maffei was in a strange mood during the conference call with financial analysts. He was much more upbeat than usual, and gave the impression at times of whistling into the wind. Uncharacteristically, he suggested that analysts should increase earnings per share by 3 cents above the current consensus of 39 cents for the next quarter: normally he is very conservative in such comments. Maffei is known for the extent for which he engages in "guidance bias" however. The conference call was surreal in that there was an implicit assumption that it would be business as usual for Microsoft, and that the trial would have no effect. It certainly was not mentioned, but all the signs are that Microsoft's share price could take a massive hit after Judge Jackson announces his decision on the findings of fact. "Software as a service is a reality" Maffei said, pointing the way to the future. He expects that smaller businesses will sign up first, and that the "annuity stream" will have "virtually no impact on the revenue stream" for the next "two to three years". The reason's clear enough: Microsoft will have to offer an incentive to get people to burn their boats and sign up for a lifelong cruise in the SS Microsoft. Maffei also observed that there were "a plethora of ASP models" and that Microsoft would be trying several. At some unspecified future stage, Maffei expected that Windows and Office upgrades would be released at the same time. So far as future quarters were concerned, Maffei said there was potential for a flat Q2, Q3 and Q4, with greater potential for Q4 to be up. He saw a trend to more and more corporate agreements, with less retail. So far as Windows CE was concerned, Maffei said it was "a very competitive environment" and a long-term bet. It was especially interesting that Maffei should say that it was "less than great news with Philips" (which announced recently its withdrawal from CE for hand-helds in favour of a move to smart phones). Financially, CE has little impact on Microsoft's results, Maffei said, and it did not generate any significant current revenue. Jill Barad, the former Microsoft director who announced her resignation recently, reported the proposed sale of two parcels of shares recently, one on 1 October for $3.6 million, and one a week later, for $3.8 million. The timing was perhaps unwise: it was between the end of the quarter and the announcement of the results. If Microsoft's share price falls dramatically in the near future, she could be the subject of shareholder action or an investigation. Maybe, however, she was symbolically washing her hands. ®

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