Smoke, mirrors and accounting: MS breakup just got harder

Analysis Microsoft's juggling of its accounting practices last week might have been made under cover of legal necessity but there are a couple of upsides from the company's point of view as well. The reporting format it's gone for makes it trickier to implement Judge Jackson's judgement, temporarily set aside, that the company should be split into two. And although superficially it looks as if it'll be easier to see which of the company's revenue streams are performing, the reverse is the case when it comes to Windows and Office.

In future Microsoft will report income in five categories, one for Windows and Office, (it's major current revenue sources), and four others. The result is that it will not be possible to know the extent to which the revenue for Office and Windows has changed. As for the antitrust matter, by presenting Windows and Office as part of the same organisational unit, Microsoft is doing precisely the opposite of what it should, under Jackson's strictures. Wasn't it supposed to be coming back with proposals as to how a split between the OS and the apps divisions should be implemented?

It's likely that Microsoft is expecting a downturn for Office and/or Windows revenue in its Q1 results on 18 October, and the changes make it possible to disguise this. It would be surprising if Microsoft has not been adversely affected by the European downturn that Intel recently reported; financial analyst Rick Sherlund of Goldman Sachs is predicting just a 5 per cent increase in revenue compared with the year-earlier quarter. This would probably mean that quarterly revenue would be down compared with the previous quarter.

Microsoft's reasons for making the accounting change were explained by CFO John Connors: "We thought it was important to give the community transparency on what we've been doing in the past and how we're doing in the future." He added that the change would make it possible "to see how we were doing in certain segments that might not have been as clear in the past". Up to a point, Lord Connors. Previously Microsoft had reported Windows platforms; Office productivity applications and developer; and consumer. In FY2000, 40 per cent of Microsoft's revenue was from Windows, and 44 per cent from applications such as Office & productivity.

For FY2000, if the results were re-stated, 71 per cent of Microsoft's revenue would have been in the first of the five business segments; 18 per cent in the enterprise software and services segment; 7 per cent in consumer software, services and devices; less than 1 per cent in consumer commerce investments; and 3 per cent in "other" (Microsoft Press and hardware).

By dividing Windows desktop, server products, and CE into three of the segments, Microsoft makes it difficult to work out the real trend in Windows sales, since in each case there are other products in the same segment, so making it impossible to break out Windows sales. Microsoft also said in an analyst call that .NET revenue would appear in all five segments.

Accounting rule SFAS 131 requires disclosures about business segments to be based on the internal organisation, and the disclosure of revenue and operating income to be based on internal accounting methods, so Microsoft is effectively saying that Windows (with the exception of server and CE) and Office have been combined both organisationally as well as for accounting purposes. It's not hard to guess why this has been done. Apart from a desire to paper over any income fissures, there can be little doubt that Microsoft's prime purpose in making these changes is to make it more difficult to bring about the splitting of the company, as Judge Jackson ordered in his final judgement. (The judge also revealed last week that breaking-up Microsoft was not his "remedy of choice", but that he had ordered this because of "Microsoft's intransigence".)

In another finance-related announcement, Microsoft said it would take a $350 million one-time charge this quarter in order to conform with the Financial Accounting Standards Board FAS 133 rule which mandates showing the cumulative loss from derivatives - investments where the value is tied to a stock option, interest rate swap agreements or some hedging activities. Microsoft will also have experienced a sharp downturn in the value of its investment in Apple unless following Friday's decline, unless of course it has covered its position. ®

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