More Top-Line Pain Ahead for Microsoft

Microsoft's (MSFT) deferred revenue, a recent area of concern, should steady later this year -- but not before suffering a hit of more than $1 billion, the company's CFO said Tuesday.

"We've got a $1.1 billion hole we've got to fill going into [fiscal year] 2005," CFO John Connors said Tuesday at an analyst meeting Webcast from Boston. "We definitely have a tougher hurdle going into [fiscal year] 2005 than we had going into [fiscal year] 2004."

About two years ago, Microsoft enjoyed a boost of about $1.1 billion to deferred revenue, which has since been flowing to the company's income statement. The boost came as a result of a deadline set for Microsoft customers to transfer to a subscription payment program or else face higher prices for upgrades, Connors explained.

The result was a big rush by customers to buy two-year contracts. However, as those contracts expire this year, only a minority of customers is expected to renew, Connors acknowledged Tuesday. That low renewal rate was reflected in the larger-than-expected $395 million decline in deferred revenue in the second quarter, as reported by Microsoft last week.

Connors comments did nothing to alleviate concerns about the firm's declining deferred revenue, which have weighed on Microsoft's shares for the past quarter. Recently, Microsoft shares were down 23 cents, or 0.8%, to $28.57.

Connors estimated that about 30% of the two-year subscription customers -- many of which are small- and medium-sized businesses -- would renew. By contrast, about two-thirds to three-quarters of large companies who buy subscriptions typically renew, Connors said.

That's a higher renewal rate than some Wall Street analysts are projecting. Goldman Sachs analyst Rick Sherlund is now estimating that 10% to 20% of customers who signed those two-year deals will renew, in line with Sanford C. Bernstein analyst Charlie Di Bona's estimate of 15%. (Sherlund and Di Bona have outperform ratings on Microsoft; Goldman has done banking with Microsoft while Bernstein's parent company, Alliance Capital, holds Microsoft shares.)