Questions Linger Despite Microsoft's Strong Results

Looking ahead, Microsoft expects third-quarter revenue to range from $8.6 billion to $8.7 billion and third-quarter earnings to range from 28 cents to 29 cents a share, excluding an equity compensation charge of 5 cents a share. Analysts' estimates called for revenue of $8.54 billion in the December quarter and pro forma earnings of 27 cents a share.

Microsoft raised guidance for the full fiscal year 2004, which ends in June. Revenue is expected to range from $35.6 billion to $35.9 billion, up from previous guidance of $34.8 billion to $35.3 billion and higher than the consensus estimate of $35.3 billion. Microsoft said earnings should range from $1.17 to $1.18 a share, excluding a 35-cents-a-share equity compensation charge. That's up from previous guidance of $1.10 to $1.12 a share and the consensus estimate of $1.14 a share.

The increase in guidance is primarily due to improving market conditions, said Connors, who celebrates his 15-year anniversary with Microsoft Friday. But with record revenue quarters like the latest one, Connors suggested posting the same growth rates in fiscal year 2005 will be difficult. He cautioned investors not to assume growth will be linear and said Microsoft will likely focus more on costs in 2005, which could enable the company to show "decent absolute profit growth."

Such comments are hardly likely to prompt investors to flock to the world's largest software maker, whose stock dramatically lagged the tech rally last year. "It's inexpensive, which makes it attractive to a certain family of investors," said Michael Sansoterra, a software analyst at Principle Global Investors. "But at the same time, its growth is not as robust as many other software companies."

"I think it will attract a class of investors, but not the guys chasing the hot money," Sansoterra added. Principle holds shares of Microsoft.

On Microsoft's balance sheet, meanwhile, deferred revenue fell to $7.85 billion from $8.25 billion at the end of October. Deferred revenue represents revenue from customers paying a subscription to use Microsoft software. Microsoft first records such sales as unearned revenue on the balance sheet when a contract is signed and then recognizes it in equal installments on the income statement over the life of the contract.

Last quarter, Microsoft attributed the decline to one-time events such as a rash of virus outbreaks and a sales force reorganization, among other things. But those reasons don't wash a second time around.

"At this point, Microsoft can't chalk it up to one-time issues," Said Tony Ursillo, an analyst with Loomis, Sayles & Co., who was projecting the deferred revenue line would have come in about $200 million higher than Microsoft reported. "It's an issue with the company getting people to renew their various licensing plans." (His firm holds Microsoft shares.)