Microsoft earned US$1.55 billion, or 14 US cents a share, in its second fiscal quarter ended 31 December 31 2003, down from US$1.87 billion, or 17 US cents a share, for the same period last year.

Although the company logged a record-breaking US$10.15 billion in revenue for the period, analysts on the company's conference call repeatedly asked Microsoft CFO John Connors about unearned revenue, part is revenue deferred from previous quarters.

Unearned revenue fell sequentially US$395 million to US$7.85 billion even though Microsoft executives said the company is seeing growth both sequentially and year over year in annuity license billings.

Upgrade Advantage contracts Microsoft offered purchasers to help them transition to 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 multi-year annuity licenses.

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

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

 The problem is that many companies are still loathe to spend anymore than they have to on information technology. "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, says one long-time Microsoft partner.

Analysts, one of whom admitted they had been "wrapped around the unearned axle" for some time now, grilled Microsoft CFO John Connors on this point. Connors said it is too early to tell what these users will do.

 "This is a large pool of customers who have never been annuity buyers and will continue to buy license only. ... Clearly we have more conservative assumptions for these customers moving from Upgrade Advantage to Software Advantage than Enterprise Agreement renewal rates," he said.

"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 system 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 in particular has been disappointing, partly due to still sluggish IT spending and its October ship date.

Microsoft said revenue for its Information Worker unit, home of Office, was up 27 percent.

Said one large integrator: "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."

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.