What Happened to Cash-King?

Microsoft's Cookie Jar

By Rob Landley (landley@flash.net)

Austin, TX (Jan. 20, 1999) -- Microsoft (Nasdaq: MSFT) has been the Rule Maker's second-best investment so far. Although Cisco (Nasdaq: CSCO) has outperformed it on an annualized basis (remember, we haven't held Cisco as long), few investors would complain. Microsoft will almost certainly qualify for the Fool's "daily double" feature by the time the anniversary of our purchase rolls around. The company just had one of the most profitable quarters in its history. On paper, it looks darn good. (Cue the ominous "impending bad thing" music.)

Microsoft is still finding fresh branches of government to tick off, now adding the Securities and Exchange Commission to the list. According to an article in Seattle Weekly, Microsoft just settled a wrongful termination lawsuit, filed under the Whistleblowers Protection Act by its ex-chief of internal audits Charlie Pancerzewski. He claims he was forced to resign after reporting to his bosses (Microsoft Chief Financial Officer Mike Brown and Microsoft Chief Operating Officer Bob Herbold) his suspicions that Microsoft's profit figures had been systematically distorted for years.

The illegal accounting practice detailed in Mr. Pancerzewski's testimony is known as a "Cookie Jar" reserve policy, where a company borrows money against earnings during good quarters in order to set "reserves," thus subtracting the money from earnings and tucking it away off the balance sheet. Then, in bad quarters, a reserve can be cancelled to add back the money and invisibly inflate earnings. This would smooth out the natural volatility endured by any company that sells to the public and would allow it to beat earnings estimates by a controlled amount each quarter no matter how its business actually performed. The down side is that the company would be lying to its investors about its current income, and this practice would violate both Generally Accepted Accounting Principles (GAAP) and SEC regulations.

I've repeatedly said Microsoft does not have a true repeat purchase business model. These allegations, if true, would not surprise me at all. If Microsoft treats its competition, customers, partners, standards organizations, and even the federal and state governments with identical "hardball" tactics, why should its investors be any different? With billions of dollars of employee stock options outstanding, and billions more of outstanding "put" options sold on its own stock for extra cash, (explained as part of its stock buyback program) a sudden decline in the company's stock price (anyone remember the "Asia scare?") could cause a multi-billion dollar cash outflow if it triggered the puts or employee options. Add to that a possible exodus of developers no longer tied down by stock options and what preventative action would you consider to be "in character" for Microsoft's management?

But don't take my word for it, read the article for yourself. Here's the link:

Seattle Weekly: "Microfraud?"

And here's some good discussion on the subject originating from the geek community:

Slashdot: Editorial - Discussion of Seattle Weekly article among geek community.

To compensate for its lack of significant repeat purchase business, Microsoft develops new products to replace its old ones. Unfortunately, it's not very good at it. Microsoft's next iteration of Windows, "Windows 2000," has been delayed yet again, with the third official "beta test" release slipping until at least April. As for the fact that the company has "release candidates" for "beta" code ("This MIGHT be good enough to be called a test version, but we're not sure. Can you guys out in the real world try it out and let us know?")... Personally, that bothers me.

When the final version of W2K will actually ship is anyone's guess, but it's already too late to take part in the Y2K upgrades sweeping the industry. Instead it must compete against them and convince users to upgrade twice. The sales surge Microsoft just had may have been Y2K related, or maybe it's disposing of some of those alleged "Cookie Jar" reserves in case the company gets audited by somebody it can't fire. Who knows? :)

Read about it here:

ZDNet: Windows 2000 delayed again.

ZDNet: Editorial - ZDNet's editorial director is not surprised.

Talk about it in the Rule Maker Companies message folder linked below.


01/20/99 Close

Stock  Change    Bid
AXP   +1 1/2   102.00
CHV   -  9/16  80.00
CSCO  -  1/4   106.13
KO    -  5/8   63.44
GPS   +1 1/8   59.00
EK    -  5/8   68.13
XON   -  1/16  71.00
GM    +  15/16 88.94
INTC  -1 1/8   138.25
MSFT  +7       162.63
PFE   +4       119.69
SGP   +2 5/16  54.75
TROW  -  1/32  33.88
                   Day   Month    Year  History
        R-MAKER  +1.32%   5.22%   5.22%  36.94%
        S&P:     +0.36%   2.22%   2.22%  24.91%
        NASDAQ:  +0.30%  10.16%  10.16%  44.96%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   24 Microsoft     78.27    162.63   107.78%
   6/23/98   34 Cisco Syst    58.41    106.13    81.69%
    5/1/98 55.5 Gap Inc.      34.06     59.00    73.22%
   2/13/98   22 Intel         84.67    138.25    63.27%
    2/3/98   22 Pfizer        82.30    119.69    45.43%
   8/21/98   44 Schering-P    47.99     54.75    14.08%
    2/6/98   56 T. Rowe Pr    33.67     33.88     0.60%
   5/26/98   18 AmExpress    104.07    102.00    -1.99%
   2/27/98   27 Coca-Cola     69.11     63.44    -8.20%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo    72.41     88.94    22.83%
   3/12/98   20 Exxon         64.34     71.00    10.36%
   3/12/98   20 Eastman Ko    63.15     68.13     7.88%
   3/12/98   15 Chevron       83.34     80.00    -4.01%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   24 Microsoft   1878.45   3903.00  $2024.55
   6/23/98   34 Cisco Syst  1985.95   3608.25  $1622.30
    5/1/98 55.5 Gap Inc.    1890.33   3274.50  $1384.17
   2/13/98   22 Intel       1862.83   3041.50  $1178.67
    2/3/98   22 Pfizer      1810.58   2633.13   $822.55
   8/21/98   44 Schering-P   2111.7   2409.00   $297.30
    2/6/98   56 T. Rowe Pr  1885.70   1897.00    $11.30
   5/26/98   18 AmExpress   1873.20   1836.00   -$37.20
   2/27/98   27 Coca-Cola   1865.89   1712.81  -$153.08

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo  1230.89   1511.94   $281.05
   3/12/98   20 Exxon       1286.70   1420.00   $133.30
   3/12/98   20 Eastman Ko  1262.95   1362.50    $99.55
   3/12/98   15 Chevron     1250.14   1200.00   -$50.14

                              CASH    $120.62
                             TOTAL  $29930.25

Note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.

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