October 27, 2003, 8:56 AM — An unexpected large drop in Microsoft Corp.'s unearned revenue has financial analysts worried that the company's biggest challenge is not Linux or an IT spending dip, but an installed base that's rejecting its software subscription plan.
The drop in unearned revenue overshadowed Microsoft's strong fiscal first quarter performance, with earnings above Wall Street expectations.
Unearned revenue is deferred revenue for license agreements that is recognized over the life of those agreements. The amount of unearned revenue on Microsoft's balance sheet dropped US$768 million. This is significantly more than the forecasted decline of between $200 million and $300 million.
Microsoft blames the drop on slower sales due to a reorganization in its Business Solution sales force, sluggish IT spending and seasonal factors. Also, the company was distracted from selling software subscriptions because of security issues such as the Blaster worm, Chief Financial Officer (CFO) John Connors said Thursday in a conference call.
Financial analysts, however, see the drop as a "wake-up call" and an early warning to longer term challenges with selling multiyear agreements because software buyers don't see enough value in those to sign on.
"The ongoing challenge for Microsoft is delivering enough value with the Software Assurance (SA) program to convince customers to continue in a software maintenance program," Jason Maynard, a director at with Merrill Lynch & Co. Inc., wrote in a report released Friday.
Customers may be less interested in Microsoft's SA plan because current software suffices and there aren't many new products in the near term, the analysts said. The next slew of new Microsoft products isn't expected until 2006 with the release of Longhorn, the code name for the next Windows client.
Victor Raisys, software analyst at investment bank SoundView Technology Group Corp., in San Francisco, agreed that Microsoft faces the challenge of justifying the value of SA to customers.
"With a number of new versions of products coming out this year, customers may choose to take the new versions of products and drop their maintenance agreements since these products most likely won't be updated for a number of years," Raisys wrote in a report released Friday. Raisys owns Microsoft stock.
Microsoft introduced SA in 2001 together with Licensing 6.0, a revamp of its volume licensing program. Analysts and users blasted Licensing 6.0 and SA as nothing but an ordinary price hike. Many software buyers bought Microsoft's Upgrade Advantage agreements two years ago to avoid Licensing 6.0. Those UA contracts are now set to expire and Microsoft wants to sell those users on SA.