Making Sense of Microsoft’s Third Quarter Financial Results

The success of Vista is of obvious importance to any developertargeting any Vista-only or Vista-enhanced technology, so thelatest news that Vista sales arestrong and higher than expected is of obvious interest.

It appears that Vista has been a stunning success for Microsoft,surprizing even the optimists inside the Redmond empire.This stands is a stark contrast with reports of generalconsumer apathy about this release, and many dire predictions aboutVista’s adoption (predictions that are dubious, given that Vista ispretty much assured a reasonable level of success givenits automatic sale to virtually anyone buying a new PC.Corporations naturally delay adoption of new operating systems, asthey have with every prior edition, so only a delusional expectedit to storm across business desktops).

You can see their Q3 return on the SEC site. Under the Client division, you can clearly seethat revenue has rocketed up, from $3.151 billion in Q3 2006, to$5.272 billion in Q3 2007.

There are a couple of massive, almost-Enronesque caveats tothese numbers that deserve some serious scrutiny before you startyour Vista-only product launch.

Firstly, they deferred $1.2 billion of XP sales from Q1and Q2 2007 — sales that qualified for the upgrade coupon –rolling it into this result.

Client revenue increased for the three months endedMarch 31, 2007, primarily reflecting licensing of WindowsVista, including recognition of approximately $1.2 billion ofrevenue previously deferred in fiscal year 2007 pending the January2007 release to consumers.

Counting out that rather dubious bit of accounting trickerydrops the gross revenue to a growth of just $0.8 billion over theyear earlier.

Secondly, some of the gain is attributed to the pricepremium applied to Vista Premium (effectively imposing a priceincrease over prior XP licenses, as most PC makers automaticallydeliver the Premium edition.)

During the quarter, the OEM premium mix increased 18 percentagepoints over the prior year to 71% driven by the demand for WindowsVista Home Premium.

Not to mention that the computer market in general has grownover a year earlier.

Based on our preliminary estimates, total worldwide PC shipmentsfrom all sources grew 10% to 12% from the third quarter of theprevious year and approximately 8% to 10% from the first ninemonths of the previous year driven by strong consumer demand inboth emerging and mature markets.

Not quite as successful as some reports are claiming: After ayear of market growth, subtracting the hard-to-rationalizerolling-forward trickery, and considering that the price for theoperating system was effectively raised via the Premium edition,and suddenly the situation doesn’t look quite as rosey.

Rough back-of-a-napkin calculations have OS unit sales remainingrelatively flat after incorporating in market growth. If thisexceeded inside-of-Microsoft estimates, then clearly they’re eitherlying, or they were expecting an implosion. Applauding aboutVista’s lofty percentage of OS sales should be quelled by thereality that virtually every new client PC OS sold now is Vista –if a corporation does want XP, their recourse now is to buy a Vistalicense that grants them the right to install XP, though it’llcarefully get added as another vote of confidence by the Microsoftbeancounters.

There are several other surprizes in their Q3 report. Forinstance that the entertainment division (Xbox, Zune) saw revenuedrop over a year earlier, and that the Online ServicesBusiness — this is where Microsoft put a lot of attentionrecently, with the huge push of the Live platform — saw amarginal revenue increase, with a significant loss increase.

The only bright spot of the whole quarterly report, from myperspective, is the business systems division: Office 2007 has seengood adoption and has very healthily contributed to earnings.

Reports that this quarterly report validates Vista’s success areunfounded. Further, it puts a hugequestion mark over Microsoft’s web and hardware initiatives (thecomplete failure of the diversification to actually add to thebottom line, instead of just drowning in losses — excused early onas toothing pains, but there doesn’t seem to be a point whenthey’ll actually make money — should raise serious concern.Microsoft is still held aloft by Windows and Office).