And GNU/Linux is partly responsible for it

WHEN Microsoft unleashed its previous financial report, we provided evidence to show that decline was muchly inevitable. A lot of what we put forth back then still applies. Since then, we have presented past allegations of financial fraud at Microsoft. These allegations came from the very inside, indicating or at least suggesting that for quite some time Microsoft had been playing the infamous 'bucket game' to improve perceptions around its financial results and overall health. Novell may be the same thing, but that's another story.

At the moment, Microsoft may be heading towards debt, which its board of directors has already approved. In the mean time, in order to keep up appearances, Microsoft turns its savings into acquisitions, i.e. revenue through artificial growth. This is a very important observation which is worthy of special attention, so again:

Microsoft converts its cash reserves into revenue and income, but this is not sustainable because Microsoft's bottom line is declining.

With that in mind, let us start today's assessment of Microsoft's financial results, which it published on Thursday. We rely on external sources that we reference, so accusations of inaccuracy -- if any -- should not necessarily be directed at us.

Bad Forecast

Microsoft cut its forecast last week. The stock sank as a result, but some people quickly forgot all about it due to the important report which came shortly afterwards.

Microsoft had already lowered its forecasts in previous quarters in order to meet or to beat them. This is another important point which is missed by many reporters. Microsoft adjusts and readjusts its goals based on its prospective ability to satisfy the market, so it always gets to say that it beat expectations and its public image benefits from this.

Here is some articles about the latest forecast being altered:

• The Australian: Microsoft lowers full-year outlook



• Associated Press/Forbes: Microsoft issues weak outlook for current quarter



• MarketWatch: Microsoft, Juniper shares lose steam after outlooks



• Reuters: Microsoft seen lowering outlook as economy weighs

The Microsoft-focused Ivy Lessner, who is almost always bullish when it comes to this company, was not impressed. Who could possibly describe such a thing as good news? There are some answers to this question in the IRC logs.

Microsoft Cuts Outlook, Wary of Economy

The company's lower financial outlook on Thursday is assuming a mild-to-deeper recessionary environment, CFO Chris Liddell said on the company's fiscal first-quarter earnings conference call.

It is rather amusing that only a day later, Microsoft and its more obedient press pretended that Microsoft was not (or was hardly) affected by the economical climate. How quickly they forgot.

Results

Joe Wilcox, who is biased in Microsoft's favour, summarised it thusly:

Microsoft started off fiscal 2009 with solid quarterly earnings. But the future doesn't look as bright.

Market Watch had a similar take:

Microsoft shares gyrate after mixed report

Software giant beats estimates, but trims forecast for current period

This still misses some of the facts which a divisional break-down would expose. Not everyone could be easily deceived and not everybody was impressed. Here is a portion of an article from IDG:

Microsoft Corp.'s Client revenue, which virtually all comes from sales of Windows Vista, grew just 2% year over year to $4.22 billion in its first quarter of 2009.

"That fell pretty far short of Microsoft's expectations," said Matt Rosoff, an analyst at independent research firm Directions on Microsoft. "That's always a worry, since it's the core of the company's business."

Shelved away are some interesting figures suggesting a significant change in operating system sales. It is down 1% in terms of revenue as customers adopt non-Premium (i.e. not Ultimate and Business) versions of Windows Vista. There are actually other reasons for this and shall come to this in the moment. It's to do with Windows XP.

Erosion of Savings and Budget Cuts

As stated at the beginning, Microsoft's cash piles grow thinner, but let's look a little more closely at some numbers in order to explain what is happening.

For starters, as stated in TGDaily, Microsoft's market value has sunk like a rock since the beginning of the year. It's already below $200 billion.

Microsoft market cap drops below $200 billion

Tech stocks was hit once again hard during a rough trading session that shaved 514.45 points from the Dow and 80.93 points from the Nasdaq index. A quick look at stock values revealed a few winners and losers so far this month.

On the winning side are Motorola, Ebay, Apple, Cisco, Google, Novell and Oracle, all of which were able to either keep their stock values stable or even showed a slight increase during this shaky month.

The value of the company (including assets) is one thing, but another is bank balance. As reported and shown by Venture Beat, Microsoft's cash is being thrown away, partly due to its relentless attempts to grow revenue.

Buried in the first quarter earnings report from Microsoft is an astounding fact. For the first time that I can remember, Microsoft closed the quarter with less cash than Apple. Cash, cash equivalents and short-term investments for Microsoft add up to $20.7 billion. Apple, meanwhile, closed the quarter with $24.5 billion.

For visual evidence, see the chart here.

As Microsoft's bank balance approach zero (heavy buybacks still in progress), there are budget cuts too. This new one is measured at half a billion dollars:

The unexpected news in today's Microsoft's earnings conference call? The company's statement that it would cut up to $500 million from its budget this year.

An anonymous Microsoft employee, along with many of the responses in his blog (mostly Microsoft employees), indicates that prospects do not seem rosy even to those who view it from the inside where optimism and morale are pervaded.

So, if your team had to get by with 10% less budget, how do you think it would be best addressed?

IDG published the article "Microsoft CFO outlines plan to weather economic crisis." Microsoft is aware of the fact that it is by no means immune to anything.

To lure and retain customers who are looking "to do more with less" in the challenging economy, Liddell said Microsoft will focus on providing "high-value products at a low total ownership cost as a competitive advantage."

GNU/Linux Harms Microsoft's Profits

The decline in Windows revenue was mentioned earlier and it echoes a similar trend which was spotted and reported back in April of this year. The reason for that, according to many sources, is the sudden rise of sub-notebooks, many of which (estimated at 40% or higher) run GNU/Linux. Here are some articles or posts about it:

1. Microsoft sales tumble from quarterly high

Netbooks running Windows mean growth but relatively low income as they do not run money spinning versions of Windows, like Windows Vista Premium Edition. Microsoft said it was too early to say how much netbooks are cannibalizing traditional sales.

2. Linux Netbooks Impact Microsoft Sales

Now, for the twist: It’s no secret that multiple Linux distributions — particularly Canonical’s Ubuntu and Novell’s SUSE Linux, among others — have gained major momentum on Netbooks. In response, Microsoft has had to cut its Windows OEM prices to make sure Windows is a major force in the Netbook market.

The VAR Guy predicted in July that Netbooks running Linux would proliferate the market. It’s already happening.

How much does Microsoft charge Netbook makers for Windows? Alas, The VAR Guy must concede that he doesn’t know for sure. But clearly, given Microsoft’s latest financial statements, the move to new hardware form factors coupled with open source is causing the software giant some pain.

3. Microsoft: Client Revs Whiff; Blame The Rise of Netbooks; Reduced Guidance Reflects Anticipated Recession

The company notes that growth in the client division was four points short of guidance.

4. Netbooks Slam Shut On Vista Sales

Revenue from Microsoft's key Windows franchise grew just 2% in the most recent quarter as more PC buyers opted for smaller, more nimble, netbook-style devices that don't need a fat OS like Vista. Does Redmond have an answer for this trend?

[...]

Redmond's problem: An increasing number of computer buyers, mostly in high-growth, price-sensitive emerging markets, are realizing that they can get by with so-called netbooks for most of their online requirements. It's a fact that's leaving Windows Vista out in the cold in some of the world's fastest growing tech markets.

Netbooks, from offshore manufacturers such as Taiwan's Asus, typically lack the horsepower to run the big and bulky Vista. But they're fully capable of performing routine computing tasks such as e-mailing, Web surfing, and instant messaging. Many models feature the free Linux OS.

5. Microsoft: NetBooks Affecting Windows Revenue

Matt Rosoff, an analyst with Kirkland, Wash.-based research firm Directions On Microsoft, said one area of concern for Microsoft is the falling percentage of premium priced versions of Windows versus non-premium versions, which could be the result of more people buying NetBooks.

In order to fend off GNU/Linux, Microsoft brought back XP and it 'sells' Windows for mere pittance. Fortunately, there is no free lunch and dumping proves costly. Miserable and predatory pricing is all that remains, just as Glyn Moody predicted.

Web Failures

The Web division performed abysmally also. Examples of this can be found in:

1. Microsoft 2.0 feels data center pinch

All that spending, though, has meant losses and increased costs associated with any revenue that it does earn. Losses more than doubled suddenly in the summer's fourth quarter while revenue has fallen each quarter since January.

2. Windows to the future

The problem for the Seattle-based group is that it is approaching a crossroads. For decades, it has sold PC users, both professional and consumer, a full suite of products. Yet the future is à la carte. Instead of buying a software licence for everything that might conceivably be needed, customers will pick and choose - a slice of word processing please but hold the PowerPoint. Software will increasingly be offered as a (low-margin) service, run from the internet and piped into the building as necessary.

3. When will Microsoft regain its identity?

And given its laughable search market share and its inability to make any headway in the advertising market, I think it's safe to say that Microsoft committed a major blunder.

And now, it's happening all over again.

4. Earnings: Microsoft's Profits and Revs Up; Online Losses Increase

Earnings: Microsoft's Profits and Revs Up; Online Losses Increase

[...]

Division wide: in its Entertainment and Devices Division (EDD), which includes XBox and Zune, revenues came in at $1.81 billion, down from $1.93 billion in the year-ago quarter. Operating income for the division was $178 million, up from $167 million in the year ago quarter. In its Online Services Business (OSB) unit, which includes MSN and other online advertising services, revenues came in at $770 million, up from $671 million in the year ago quarter. Operating losses for the division widened significantly, to $480 million, from $267 million in the year ago quarter.

We recently mentioned parts of Microsoft's Web division getting shut down.

Not So Entertaining Anymore

Microsoft's other divisions did not receive much love either. Such as the case with products like Zune and XBox 360, which suffered further decline. By the numbers:

1. Microsoft Revenues Down at Xbox/Zune Division

Xbox 360 and PC game revenue decreased by 22%, which the company attributed in part to the absence of a blockbuster like last year's "Halo 3."

2. Microsoft's Q1 was not particularly riveting

Microsoft (NASDAQ: MSFT) had, if you'll pardon the pun, a soft first quarter. The data just didn't do anything for me. The software giant, which competes with Apple (NASDAQ: AAPL), Yahoo! (NASDAQ: YHOO), Google (NASDAQ: GOOG) and IBM (NYSE: IBM), reported after the close of the regular session on Thursday. The stock was down slightly in the after-hours session, which seemed reasonable enough to me.

[...]

Sales for Xbox 360 declined 6%. Microsoft has to get the word out that the Xbox 360 is the console to own. The gaming device is a key growth area for the company.

Analysts

The National Post published "Tough times ahead for Microsoft, analysts predict." Here is a portion from it.

Like most technology companies, Microsoft Corp. has seen its fortunes dwindle over the past year. Through a failed acquisition of beleaguered search operator Yahoo! Inc. to the bad public relations image it has tried to shake off through a much-ballyhooed advertising campaign with Jerry Seinfeld, Microsoft’s stock has dropped almost 30% over the past year, including a 7.8% plunge during Wednesday’s trading session on the Nasdaq index to US$21.53.

Even the Microsoft enthusiasts over at Motley Fool were rather disappointed

Yes, the days of fat feasts at Mr. Softy are over. Last night's fiscal first-quarter results for the world's biggest software company confirm it.

Conclusion

At risk of seeming repetitive, it ought to be stressed that whenever Microsoft releases figures, it is important to look more closely at the sobering figures for oneself. This rule applies to almost any company and every press release or conference.

A lot of journalists are lazy or biased (or both), so they merely echo Microsoft's claims, which shrewdly obscure all the weak(er) points. Also important to realise is the fact that Microsoft is losing money based on its bank balance, but it's buying assets that continue to give an illusion of growth. Despite acquisition, Microsoft value as a company continues to drop pretty fast. ⬆

"There is such an overvaluation of technology stocks that it is absurd. I would include our stock in that category. It is bad for the long-term worth of the economy."

--Steve Ballmer