VideoFew observers expect Judge Thomas Penfield Jackson to go so far as to break up the company. Some expect the court instead to require Microsoft to make the source code for its operating system available to outside software developers. The spokeswoman would not comment on that observation but did say that Microsoft was open to a settlement if it could continue to add new features into its operating system. But so far, she says, the government has refused to accept that possibility.
At any rate, a decision in the antitrust case isn't expected to be made until year's end, at the earliest. Any judgment that imposes stiff penalties on Microsoft will no doubt be appealed to the highest courts--a process that could take an additional two years or more.
One thing seems clear: Greg Maffei may well be a CEO somewhere by the time the antitrust battle is over.
The Dark Side of Deferral
Does Microsoft Understate Its Growth?
Microsoft's argument that it isn't a monopoly would only be helped by the impression that its revenue growth is slowing. But a big part of the slowdown may simply reflect a change in the way the company recognizes revenue.
A growing portion of Microsoft's revenue isn't recognized when payment is received, but is deferred instead. As of last March 31, the company had almost $4.2 billion in "unearned" revenue as a liability on its balance sheet, compared with $2.9 billion on June 30, 1998. Without such deferrals, Microsoft's revenue growth would have remained above 30 percent in fiscal 1998.
Granted, the practice of deferring revenue in this fashion is required under generally accepted accounting principles to the extent that software contracts call for the manufacturer to supply product support and unspecified upgrades at no additional charge. And Microsoft insists that it hasn't changed its revenue-recognition practices. Instead, it says the growing amount of its deferred revenue reflects the fact that its sales are increasingly contingent on product support and upgrades.
The company explains that it defers approximately 10 percent to 25 percent of its revenue from selling Windows to PC makers and other original equipment manufacturers, its main sales channel; that it expects to recognize this revenue over roughly three years; and that it will defer the same amount of Office 97 revenue, recognizing it over an 18-month period.
With the total amount of deferred revenue on its balance sheet now equal to roughly 80 cents a share (on an undiluted basis), or almost two quarters' worth of current earnings, analysts now pay as much attention to this liability as to earnings. And they draw comfort from seeing the amount of the liability grow. "We believe the company's core earnings power is higher than printed and is held back, in part, by the company's aggressive revenue-deferral efforts," noted Mary Meeker, an analyst for Morgan Stanley Dean Witter, in a recent report.
To the extent that Microsoft recognizes a portion of the up-front cash payment over subsequent periods, the practice converts a one-time payment into a stream of revenue, just as its forays into E-commerce, cable television, and wireless communications are intended eventually to produce.
A Whistle-Blower's Tune
But some analysts also suggest that Microsoft may use the deferred amounts to manage earnings, which violates both GAAP and federal securities law. In a little-reported whistleblower's lawsuit settled last year, Microsoft's former chief of internal audit, Charles Pancerzewski, charged that the company had set up a cookie-jar reserve that it used to eliminate fluctuations in its earnings prior to his resignation in 1996, and that he had been forced to resign after calling attention to the practice.
In his lawsuit, Pancerzewski cited Microsoft's use of deferred revenue as a potential means of creating such a reserve, and brought in William Simpson, a former SEC accountant in its Los Angeles office and now a consultant, to testify that Microsoft did indeed manage its earnings through such means, according to court documents. Microsoft convinced the court to seal Simpson's testimony from public view, and both he and Pancerzewski declined to be interviewed for this article.
Nor would CFO Greg Maffei comment on the lawsuit. (Repeated attempts to reach former CFO Mike Brown were unsuccessful.) But Maffei strongly defends the company's use of deferred revenue, and says it doesn't use the amounts or any other item as a means of managing earnings. "We manage the expectations about earnings," he says. They are "two different things."
As for how Microsoft determines the amount of revenue it defers, Maffei insists "we follow GAAP. That unearned revenue is not managed earnings in any way, shape, or form. It's quite the opposite. When people talk about managing earnings, they think you've got some hidden pocket here or there that you're pulling [money out of]." But he adds, Microsoft's deferred revenue is "entirely visible. It goes in under a set of rules that we proclaim to analysts. We reviewed that with the SEC, and they agreed."
Despite the recently announced SEC inquiry into Microsoft's accounting practices, Maffei says analysts can still draw comfort from the amounts of revenue it defers. He notes that the inquiry "to our knowledge" has nothing to do with the deferred revenue, though a spokesman for the commission declined to confirm that.
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