Microsoft Posts Big 2Q Sales, But Doubts Around Upgrades Persist

However, industry analysts on the company's conference call repeatedly asked Microsoft CFO John Connors about unearned revenue, part of which is deferred revenue from previous quarters. Unearned revenue fell sequentially by $395 million to $7.85 billion, even though Microsoft executives said the company is seeing growth both sequentially and year over year in annuity license billings.

Microsoft's fiscal second-quarter earnings also dipped. The company posted a profit of $1.55 billion, or 14 cents a share, in the period, down from $1.87 billion, or 17 cents a share, a year earlier.

Part of the reason for the decline in unearned revenue is that the Upgrade Advantage contracts Microsoft offered purchasers -- to help them transition to a new licensing model -- are set to expire over the next few quarters, and the company has no idea if those buyers will move to its preferred multiyear annuity licenses.

"The Upgrade Advantage contracts have made growing the unearned balance difficult and somewhat mask the acceptance of our annuity offerings in the market over the last six quarters," Scott Di Valerio, Microsoft's corporate controller, told analysts on the conference call.

Microsoft has been laboring mightily to move more customers to that subscription model, pushing three-year Software Assurance deals that would cover all updates and fixes for designated products during that period.

The problem is that many companies are still reluctant to spend anymore than they have to on IT. "You used to peg software upgrades to hardware upgrades, and that was an easy three-year cycle. Now companies are saying, 'No, let's wait for four, even five years [on software upgrades]," said one long-time Microsoft partner, who wished to remain anonymous.

Analysts, one of whom freely admitted that she had been "wrapped around the unearned axle" for some time now, grilled Microsoft's CFO on that point. Connors said it is too early to tell what those users will do. "This is a large pool of customers who have never been annuity buyers and will continue to buy license-only," he said. "Clearly, we have more conservative assumptions for these customers moving from Upgrade Advantage to Software Advantage than Enterprise Agreement renewal rates."

"We now have a lot broader product offering than previously, but we're also pragmatic. If customers want to buy license-only, we have the program," he noted.

In other call highlights, Connors reiterated the challenge Linux is posing to Microsoft's core operating-systems business.

"It's real clear that Linux is probably the most significant competitor to the Windows platform. Both Windows and Linux continue to grow, and both are benefiting from the shift to Intel hardware," he said.

The executives said they are pleased with the reception for Small Business Server 2003 and Office System 2003, the big product launches for the quarter. But company insiders and partners have said privately that the take-up of the new Office has been disappointing, partly due to still-sluggish IT spending and its October ship date. Microsoft said revenue for its Information Worker unit, the home of Office, was up 27 percent.

"They launched at the completely wrong point in the budget cycle and in my view 'mis-described' why people should upgrade, which is the Outlook improvements," said one large integrator, who asked not to be named. However, he said Microsoft's long-term view of making Office applications a jumping-off point for tapping into back-end data and vertical applications remains sound.

Microsoft is now busily working on Service Pack 1 for Office 2003, with new features for the InfoPath and OneNote components (see story).

Other highlights from the conference call included the following:

-The Longhorn client beta one remains on tap to ship this summer.

-Microsoft Business Solutions revenue rose 41 percent to $190 million for the second quarter, largely due to increased Navision license sales.